Private wealth managers (PWMs) are increasingly investing in private alternative investment funds in search of greater returns and portfolio diversification for their clients. With institutional investor allocations reaching limits, alternative investment fund managers are increasingly targeting retail capital to secure new, large sources of fundraising growth. Access has never been greater. However, the unique features of these investments require more than the conventional know your product due diligence undertaken with respect to traditional retail investments.
Key risks of alternative investments for private wealth clients include illiquidity, lack of transparency, higher fees, and increased complexity compared to traditional stocks and bonds. As a result, these investments often require a higher risk tolerance and extensive due diligence.
Legal due diligence of alternative investments is critical for risk mitigation, ensuring regulatory compliance, identifying liabilities and providing the necessary foundation for informed decision-making and negotiation leverage.
From structuring the investment access vehicle used to make these investments through to scrutinizing the fund’s governing documents and negotiating entry, the Fund Investments & Asset Management team at Lawson Lundell LLP can assist in navigating and mitigating the risks of these complex investments to avoid or limit the impact of costly surprises down the line.
Structuring the Access Vehicle
The structure and terms of the access vehicle that a PWM will organize to invest in an alternative investment fund should achieve three key objectives: (1) tax efficiency; (2) compliance with the manager’s regulatory obligations, including with respect to investor suitability, liquidity risk management and fiduciary duties; and (2) alignment with the unique features of the target investments, including those relating to accessibility (having regard to minimum investment thresholds and entrance qualifications), timing and frequency of capital contributions, clawbacks, indemnification and liquidity. Flexibility and foresight are critical.
Examining the Fund’s Governing Documents
We scrutinize the fund's governing documents (e.g., limited partnership agreement and private placement memorandum) to understand the fee structure, redemption schedules and restrictions, investor rights, and the terms for removing a general partner or manager. There may be opportunities to negotiate enhanced transparency rights, fee discounts, representations and warranties, liquidity rights, and other risk mitigating improvements.
Importance of Transparency
Transparency provides the PWM with the necessary data to discharge its fiduciary and statutory obligation to engage in ongoing performance monitoring and analysis. Ready access to financial information and prompt disclosure of adverse events and fundamental changes to investment objectives, strategies and key personnel allows the PWM to better monitor their clients’ exposure to specific risks (e.g., leverage levels, concentration and liquidity risk) and potential conflicts of interest. This oversight may help prevent nasty surprises, such as unexpected losses or the inability to redeem funds during a market downturn, by allowing for early intervention and rebalancing of the total portfolio. Enhanced disclosure also holds fund managers to a higher standard of performance and ethics, which is particularly important in an asset class with less regulatory oversight than public markets.
How Liquid is that Semi-Liquid?
Private assets are inherently less liquid than public securities. Fund structures must balance the need for investor liquidity with the long-term nature of underlying investments. So rise of the called “semi-liquid” fund is in direct response to alternative asset managers wooing retail capital. They seek to offer a middle ground between traditional illiquid private markets funds and fully liquid public market funds. Fundamentally, PWMs need to understand that these vehicles are designed to provide investors with limited, periodic access to illiquid private markets, but they carry material risks like redemption stress, valuation complexities, and operational burdens.
In times of market stress, a large number of redemption requests can outstrip the fund's available liquidity, leading to managers suspending or “gating” their fund’s redemption rights and resulting in investors not receiving their full requested amount or having to wait longer for redemptions. The PWM’s access fund must in turn have an effective mechanism to respond to this possibility. This risk cannot be considered de minimis: in 2025, several high-profile private real estate and loan funds in Canada, including those managed by Nicola Wealth, Centurion Asset Management, KingSett Capital and Trez Capital, had to limit or temporarily halt investor redemptions due to elevated withdrawal requests.