A new retail investment fund structure has appeared in Canada. The Mackenzie Northleaf Private Credit Interval Fund (the "Fund")1 uses an "interval fund" structure available in the United States2 and endorsed by the Ontario Capital Markets Modernization Taskforce3. It requires exemptive relief to launch, and we extend a big shout-out to Mackenzie for investing the time (likely more than a year) and resources working with staff of the Ontario Securities Commission ("OSC") and other Canadian securities authorities (the "CSA") to obtain the necessary relief.4 The Fund breaks new policy ground with the CSA in several ways:
- It establishes that an investment fund can hold a portfolio that is predominantly illiquid by reducing redemption rights accordingly.
- It negates the argument that less conventional investment funds must use a long-form prospectus.
- It signals that important unitholder information can be provided by mere website posting.
These breakthroughs are further discussed below.
How are Interval Funds Different?
Interval funds can invest a far greater percentage of their portfolio in illiquid assets by making a corresponding reduction to the redemption rights of their unitholders. In this case, the Fund targets to invest between 35% and 65% of its assets in two private credit funds managed by Northleaf Capital Partners that make senior secured loans5, but the amount invested in the Northleaf funds can be as high as 90%. Unitholders will be able to redeem up to 5% of the outstanding units quarterly. This represents a significant departure by the CSA from their long-standing view that public investment funds – even non-redeemable investment funds – must hold the vast majority of their assets in liquid securities. It acknowledges that retail investors can be offered a product with less liquidity in order to access less liquid asset classes.
Can Interval Funds Be Launched With Other Types of Mandates?
While the Fund establishes an important precedent for the interval fund structure in Canada, it is the first of its kind. The Fund made very detailed representations about the merits of investing in the Northleaf funds, including that historically private credit has provided a yield premium and relatively lower losses during stressed market conditions, as well as an opportunity for greater portfolio diversification. In this case, both Northleaf funds have been in existence for several year with other institutional investors, which likely provided the CSA more certainty about the nature of their activities. Extensive representations also were made about Northleaf. Future interval funds with other investment mandates may need to provide a comparable level of comfort to the CSA about the merits of the proposed mandate. U.S. interval funds currently are used to provide exposure to private credit, real estate, private equity and derivatives/insurance, so other asset classes should be possible in future Canadian interval funds.
Despite permission to own more than 10% of each underlying Northleaf fund, the Fund remains a passive investment vehicle and made representations confirming that it will not attempt to influence the Northleaf funds nor have any involvement in the loans they hold. This signals that future interval funds also need to remain passive investors and cannot become directly involved in businesses carried on by their downstream investments.
As well, the liquidity rights associated with the two underlying Northleaf funds and the liquidity of the remainder of the Fund's portfolio were key criteria in designing the redemption rights. The Fund does not have discretion to invest in other illiquid assets. Future interval funds with different underlying assets will need to establish an equally suitable match between portfolio liquidity and unitholder redemption rights. The industry likely will need to see more examples of interval funds before a clear pattern emerges.
What Are the Redemption Rights?
Technically, units of the Fund are not redeemable, but each calendar quarter the Fund will offer to repurchase 5% of its outstanding units. For simplicity, this bulletin simply refers to these transactions as "redemptions". U.S. interval funds are permitted to offer redemptions as infrequently as annually, and may cap the amount of their periodic redemptions between 5% and 25%. Accordingly, by U.S. standards, the Fund offers redemptions on the most frequent schedule possible, but with the lowest cap.
The Fund will post information and documents online prior to each quarterly redemption date, and use its communication channels to remind dealers of each quarterly redemption opportunity. This too is a significant policy departure by the CSA since, to date, the CSA have adhered to the position that mere website posting of information is insufficient for providing notice and information to investors. The Fund's website information will include historical data about all previous redemption dates. During the 21-day period prior to the redemption date, the Fund will hold sufficient highly liquid assets to fund that quarter's redemptions. If the offer is over-accepted, redemption requests will be processed pro rata, and unprocessed redemption requests will be rolled forward automatically to the next quarterly redemption date, but without priority. The Fund will publish its Net Asset Value ("NAV") during each of the five business days preceding the redemption notice deadline, and may take up to seven business days following the redemption date to calculate the redemption NAV and up to nine business days following the redemption date to pay the redemption proceeds. Mackenzie believes that, under normal market conditions, investors will be able to redeem their units within two redemption cycles.
Is an Interval Fund a "Mutual Fund"?
No. Technically, the Mackenzie interval fund is a closed-end fund (non-redeemable investment fund) because the redemption rights are structured as repurchase offers made by the Fund rather than redemption rights exercisable by the unitholders. The CSA described this as "effectively similar to redemptions" and applied to the Fund the redemption rules in NI 81-102, yet did not treat those redemption rights as making the Fund a "mutual fund". There are several possible reasons for this approach:
- Capping redemptions at 5% of the Fund's outstanding units for any given quarter may not meet the definition of "mutual fund" under securities legislation, as these rights may not "entitle the holder to receive on demand" their unit value.
- It more closely resembles the U.S. approach where interval funds are classified as closed-end funds.
- It limits distribution of the interval fund to Investment Industry Regulatory Organization of Canada ("IIROC") dealers, rather than making them available through mutual fund dealers.
Why is the Fund Using a Simplified Prospectus?
As a closed-end fund, the Fund is required to use a long-form prospectus under NI 41-101. However, Mackenzie successfully argued that a simplified prospectus with fund facts provides better disclosure to investors than a long-form prospectus and, on that basis, obtained relief to offer the Fund with investors initially receiving only fund facts (subject to adding some text box disclosure to the simplified prospectus and fund facts).6 This too is an interesting breakthrough: if the CSA accept the argument that a simplified prospectus and fund facts provides better disclosure in these circumstances, there is no reason why the same argument cannot be made for other types of funds (most notably ETFs) currently using a long-form prospectus. In the future, we may see this argument used in other contexts.
What Are the Other Notable Features of the Fund?
Below is a summary of other notable features of the Fund. In all cases, these features can be linked back to the Fund's illiquid portfolio.
Monthly subscription dates: The Fund will accept subscriptions for units at NAV on a monthly basis and is offering both retail and fee-based series. Investors will be given five business days to withdraw their purchase orders rather than the two business days normally provided by securities legislation7.
Weekly NAV calculations: Because the Fund intends to use derivatives for hedging purposes, it is required by NI 81-106 to calculated its NAV daily.8 However, the Fund obtained relief to calculate its NAV weekly (for information purposes), while monthly and quarterly NAV calculations will be used for processing subscription and redemption requests, respectively. The Fund also will calculate its NAV during each of the five business days preceding the cut-off date for submitting quarterly redemption requests.
Independent valuations of underlying illiquid assets: As part of obtaining the relief, Mackenzie was able to represent that each Northleaf fund will have its loans valued by an independent valuator on a monthly basis (to provide more information for the Fund's monthly NAV calculations). The independent valuator also will assist each Northleaf fund with its overall valuation on a quarterly basis (to provide more information for the Fund's quarterly NAV calculations for redemption purposes).
Limitation to IIROC distribution channel: As a closed-end fund, distribution of the Fund's units automatically is limited to IIROC dealers. The Fund's exemptive relief confirms this, and includes an express condition that order-execution-only (OEO) dealers not be permitted to offer the Fund. This will be confirmed through agreements between Mackenzie and the dealers that offer the Fund. Mackenzie also will provide quarterly reports to the OSC on which dealers are offering the Fund.
Risk rating: The fund's risk rating determined by applying the standard deviation methodology prescribed by NI 81-102 to a reference index produced a "low" risk rating for the Fund. However, Mackenzie determined to increase this rating to "medium" for additional reasons, such as liquidity risk.
Reduced management fees during the start-up period: The Fund's management and administration fees will be 2.25% and 0.20%, respectively, for its Series A units, and 1.25% and 0.15%, respectively, for its Series F units. However, during the initial start-up period when the Fund has not yet invested at least 35% of its assets in the underlying Northleaf funds, Mackenzie will waive a portion of its management fees according to a pre-determined grid. It is possible that at times after the initial start-up period the Fund could have less than 35% of its assets invested in the Northleaf funds (such as where the Fund holds cash awaiting a future capital call and/or its liquid investments have appreciated in value). In those circumstances, Mackenzie will not be reducing its management fee.
Concentrated investments: The Fund is permitted to invest more than 20% of its assets in each Northleaf fund and likely will invest 30% or more of its NAV in each Northleaf fund. In granting this permission, the OSC accepted a look-through argument for diversification, noting that each Northleaf fund is prohibited from investing more than 10% of its assets in any single issuer.
Fund wind-up: The Fund will be required to commence winding-up if at any time its illiquid assets exceed 90% of its NAV or if it receives redemptions requests exceeding 5% for eight consecutive quarters.
Balance sheet support by Mackenzie: The Fund's primary tools for maintaining sufficient liquidity are its limited redemption rights and an expectation that at least 35% of the Funds assets will be invested in liquid securities at all times. However, Mackenzie also provided further comfort that it will provide balance sheet support to the Fund (through itself or an affiliate purchasing units of the Fund) if needed in various circumstances, including if there is a cash shortfall to pay the Fund's capital call commitments, or to pay redemption proceeds.
Enhanced continuous disclosure: In its financial statements and MRFPs, the Fund will provide (among other additional information) a summary description of each Northleaf fund's loan portfolio. This will require some degree of coordination between Mackenzie and Northleaf.
Investor and adviser education: Mackenzie expressed a commitment to education investors and advisers about the interval fund structure and its related risks. For this reason, interested parties can view a number of articles and videos at Mackenzie's website, which explain the features of interval funds.9
What Other Factors Should be Considered?
Future interval funds also may need to consider other issues that did not appear to arise in the context of Mackenzie's first interval fund, but could surface based on different facts. They include:
Conflicts of interest: Though there is a degree of cross-ownership between Mackenzie and Northleaf, it did not appear require further relief from any conflicts of interest associated with the Fund's investments in the Northleaf funds. The CSA appear to have taken some comfort from the fact that each Northleaf fund has other arm's length institutional investors, and the Fund will never own majority interest of either Northleaf fund. However, other interval funds with different underlying investments and relationships may need to consider whether they may trigger a conflict of interest investment restriction.
Sales practices: As a closed-end fund, the Fund is not subject to the restrictions on sales practices under NI 81-105, nor was it a condition of the Fund's exemptive relief that it comply with NI 81-105. Nonetheless, the Fund's units are being offered to retail investors on a continuous basis like a mutual fund. We believe the Fund will follow the sales practices restrictions of NI 81-105, and this may become more explicit in the future.
Capital commitments: The exemptive relief notes that the Fund will invest in the Northleaf funds according to a capital call schedule. This likely addresses compliance with the restriction in NI 81-102 that prohibits an investment fund from making an investment that obligates it to make a future payment10. Future interval funds proposing to make capital commitments should keep in mind this investment restriction and seek exemptive relief, if necessary.
Will Other Managers Follow?
Fund managers likely will watch with anticipation the amount of assets the Fund is able to raise from investors willing to accept reduced liquidity in return for the chance to obtain exposure to private credit, and whether other interval funds are launched by Mackenzie. Despite the OSC being the principal regulator for the Fund, we are certain that the Fund's novel relief was discussed and accepted among all members of the CSA, such that the door is open for managers in other provinces to launch their own interval funds.
Regardless of the short-term response, feedback from other managers suggests there will be interest in future interval funds with possibly different investment focuses. However, different underlying illiquid assets will raise new considerations to be addressed through the interval fund's structure and redemption rights. Each manager will need to consider whether its proposed interval fund will meet the same standards set by Mackenzie with the Fund. Not all managers may be able to do so since the relationship between Mackenzie and Northleaf enabled it to confirm features about the Fund's underlying investments that other managers may not be able to replicate (such access to independent portfolio valuations).
The Fund's exemptive relief contains a five-year sunset clause, together with a statement that the OSC will monitor developments with the Fund and potentially seek to vary the terms of its relief. However, now that the CSA have crossed this bridge, we expect interval funds to stay and grow in popularity.
2 Equivalent interval funds are provided for in Rule 23c-3 of the Investment Company Act of 1940.
3 Capital Markets Modernization Taskforce Final Report (January 2021), Recommendation 37.
5 Northleaf Senior Private Credit Fund and Northleaf Senior Private Credit-L Fund.
6 The Fund will switch to the new consolidated prospectus format under NI 81-101 when required.
7 For example, section 71(2) of the Ontario Securities Act.
8 Section 14.2(3)(a) of NI 81-106.
10 Section 2.6(1)(d) of NI 81-102.
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