Introduction To The New Exempt Market

Like a mean lover, the stock markets toy with us. Up one day, and down the next - the changes often are clear in hindsight but little is clear in foresight. Are you a part of the growing movement who have found a solution to largely remove this volatility while retaining strong, healthy growth?

The Birth of the Exempt Market

In the 70's, baby boomers were just entering the accumulation phase. Well aware of their parents struggle with the ups and downs of the traditional market (stocks), they demanded something different - less volatility and more stable returns. For its time, the answer was groundbreaking: pooling stocks within a Mutual Fund. This pooling meant that risks were mitigated and volatility was reduced.

In recent years, funds have taken on a different personality than their predecessors (there are more funds available than stocks to put in those funds). As they became mainstream, the insulation from volatility began to disappear once again following major market trends. There has been attempts to remove this volatility with ETF's, hedge funds and various other instruments, but none have fully answered the investors call for stable, secure, simple channels of investing. All of these instruments have become a part of the traditional market.

Baby boomers are now at another turning point in their lives, demanding simplicity, security, and stable investment returns as they approach retirement. This demand to remove volatility and ensure security has led to the significant growth of the Exempt Market. As a result of this growth, the Alberta Securities Commission (ASC) introduced legislation to regulate it in September 2010. This is the first time institutional investments have been available to the retail investor in a fully regulated environment. 

What is it "Exempt" from?

In the past, private equity firms could raise capital outside of a prospectus. After meeting certain requirements, they could raise capital without filing a prospectus under specific restrictions and were in turn referred to as an Exempt Market investment. 

In more recent years, the ASC has required a document that parallels the Prospectus.  This document is called an Offering Memorandum (OM) and can typically be more detailed. The OM must be filed with the ASC prior to raising investment funds and the firm cannot deviate from its contents.

How does it compare to traditional markets?

Traditional markets (bonds, stocks and funds) typically have multiple layers. Money is pooled into investment banks which often invest in lenders that deliver the funds to the end borrower. The graphic below is a simplification of this system. Cumbersome and nontransparent, information is often limited to the short prospectus and what can be found on the internet. This nebulous model is what allowed the creation and sale of the sub-prime mortgage bundles that took down some of the most well educated and well funded investment banks in 2008. 

Recently investors are migrating to simpler and more direct investment channels looking for lower overhead, smaller investment management and in turn, less layering of fees to impede investment growth. The exempt market provides the opportunity to remove much of the overhead. 

While this model has many advantages, it also places all the responsibility on the investor and the Exempt Market Dealer (EMD) to perform due-diligence on individual firms. Ensuring your EMD has internal, highly trained analysts with in-depth experience and proven history is a key step to investing safely. It is common for EMD's to farm out their analysis leaving the bulk of the responsibility to someone who has no fiduciary responsibility to you as an investor.

In our search for a dealer, we insist they have a dynamic team of internal analysts that carry the Portfolio Manager (PM), Chartered Financial Analyst (CFA) and MBA designations. Most importantly, we require they have a fiduciary obligation to the investor and value that obligation. Our search ended with Pennant Capital Partners Inc². They use great care and prudence to select investment firms to work with. They also perform regular audits to ensure ongoing compliance and success. Their expertise surpasses that of the educated investor and financial advisor. 

Your advisor and EMD become your partner in managing your portfolio. Pennant works to perpetuate performance based management fees. Their goal is to ensure that the investor is vested equally with people managing the investment. This results in a relationship where your best interest is parallel to the best interest of the people managing the investment. When they win, you win and if you lose, they lose.

New Regulations and Legislation

The exempt market has grown significantly over the last five years. In 2008 alone the exempt market in Alberta raised $10 billion². In recognition of that growth, the ASC introduced regulations and licensing requirements on Sept 28, 2010 to bring professionalization to the exempt market sector. 

Previous to this date, the exempt market was open for anyone to sell securities. There was no requirement to gauge suitability for a potential investor and therefore no repercussions if someone sold an investment to a person who it did not suit. The new license carries with it a fiduciary duty to look out for the investor's best interest, ensure that investments are suitable for the client and that they appropriate for their risk profile. 

Prosperity Engine Inc. exists to assist investors with the prudent selection of investments that suit their respective risk profiles - ensuring security and safety while maximizing investment return. 

¹ Disclosure: Prosperity Engine Inc. is a Registered Dealing Representative of Pennant Capital Partners Inc. and advises clients in the purchase of investments offered through Pennant
² http://www.cbc.ca/news/business/story/2010/02/08/f-exempt-market-investors.html