What are the costs associated with alternative mutual funds?
Alternative mutual fund assets have recently surpassed the $26 billion mark, garnering significant appeal over the last five years in Canada.¹ But what are alternative mutual funds and how are they priced? Let’s zero in on these nontraditional investment vehicles and talk about their primary charges in Canada.
What are alternative mutual funds?
Alternative mutual funds, or liquid alternatives, are a subset of the broader alternative investment fund category, which also comprises alternative exchange-traded funds (ETFs). In the context of Canadian mutual fund legislation—notably National Instrument 81-102—alternative investment funds are prospectus-based strategies that can be marketed on a wide scale to retail investors across the country.
Unlike traditional investment strategies, alternative investment funds are permitted to use unconventional tools such as cash borrowing, short selling, and derivatives for purposes other than hedging. Previously accessible to institutional investors or accredited investors through the exempt market only, regulators in Canada have recently recognized the importance of making alternatives available to a broader investor base, granting mutual fund manufacturers a greater deal of flexibility when it comes to meeting the evolving needs of investors.
How are alternative mutual funds priced?
While alternative mutual funds are priced very much like conventional mutual funds, there’s one notable distinction: incentive (or performance) fees. Unlike a typical mutual fund, which can only charge a performance fee if it’s tied to a suitable benchmark, alternative mutual funds are permitted to charge a performance fee that’s based on the fund’s total return. Not only could this prove to be a significant drag on investor returns over longer periods of time, but it could also create an incentive for asset managers to chase alpha as much as possible (sometimes to the detriment of risk management). That being said, while it isn’t uncommon for an alternative mutual fund to charge a 10%, 15%, or even 20% incentive fee in Canada, it’s important to highlight that not all firms choose to do so.
Demystifying alternative mutual fund pricing
Unlike the cost of your typical household or discretionary item, understanding the price of an alternative mutual fund isn’t as clear-cut as looking at a price tag. Alternative mutual funds, or mutual funds in general, may have embedded fees, which make it harder to understand the all-in costs of investing.
Thankfully, through the gradual implementation of Canada’s three-phased customer relationship model (CRM), regulators are making strides in their pursuit of enhanced fee transparency. With the last phase of CRM to take effect in 2026, investors can expect more disclosure when it comes to embedded mutual fund fees (such as performance or incentive fees) in both percentage and dollar terms. This will go a long way in demystifying mutual fund pricing for investors and promote better investment decision-making overall.
A breakdown of some of the potential costs
What should investors take away from all this?
Ever since regulators made it possible to package alternative investments in a prospectus-based mutual fund structure, it’s become easier and much more cost-effective for Canadian retail investors to obtain access to this space.
With regard to pricing, alternative mutual funds are similar to traditional mutual funds, but there are slight differences. Though it’s important to fully understand the way mutual fund costs are broken down, it’s also crucial to understand a fund’s fee structure before investing. Before investing in an alternative mutual fund, it’s important to understand the fund’s stated objectives, risks, fees, and tax implications. It’s also fundamental to consider the portfolio management team’s track record, skill sets, and capabilities to ensure you’re partnering with a reliable industry player. When examining your alternatives, always be sure to do your homework!
1 Investor Economics, Insight Investments Fund Report. Mutual funds assets in Canada. Data from November 2020 and October 2024 editions.
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