Securities Law & Instruments


Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Exemption granted from the requirements of paragraphs 2.5(2)(a) and (c) of National Instrument 81-102 Investment Funds to allow mutual funds to invest up to 10% of net asset value in two pooled funds – the underlying funds are alternative funds – the underlying funds will comply with Part 2 and other requirements of NI 81-102 and NI 81-106 and limit investment exposure obtained through the use of specified derivatives.

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, ss. 2.5(2)(a) and (c), 19.1.

September 5, 2018

IN THE MATTER OF
THE SECURITIES LEGISLATION OF
ONTARIO
(the Jurisdiction)

AND

IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS
IN MULTIPLE JURISDICTIONS

AND

IN THE MATTER OF
BMO ASSET MANAGEMENT INC.
(BMO AM)

AND

BMO ASCENTTM INCOME PORTFOLIO,
BMO ASCENTTM CONSERVATIVE PORTFOLIO,
BMO ASCENTTM BALANCED PORTFOLIO,
BMO ASCENTTM GROWTH PORTFOLIO,
BMO ASCENTTM EQUITY GROWTH PORTFOLIO,
BMO SELECTCLASS® INCOME PORTFOLIO,
BMO SELECTCLASS® BALANCED PORTFOLIO,
BMO SELECTCLASS® GROWTH PORTFOLIO,
BMO SELECTCLASS® EQUITY GROWTH PORTFOLIO,
BMO SELECTTRUST® FIXED INCOME PORTFOLIO,
BMO SELECTTRUST® INCOME PORTFOLIO,
BMO SELECTTRUST® CONSERVATIVE PORTFOLIO,
BMO SELECTTRUST® BALANCED PORTFOLIO,
BMO SELECTTRUST® GROWTH PORTFOLIO,
BMO SELECTTRUST® EQUITY GROWTH PORTFOLIO
(the Initial Top Funds)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from BMO AM on behalf of the Initial Top Funds and such other mutual funds with similar investment objectives that are subject to National Instrument 81-102 Investment Funds (NI 81-102) as may be managed by BMO AM or an affiliate or successor of BMO AM (the Filer) from time to time (the Top Funds and individually, a Top Fund) for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for an exemption, pursuant to section 19.1 of NI 81-102, from:

i.              the prohibition contained in paragraph 2.5(2)(a) of NI 81-102 against a mutual fund investing in another mutual fund that is not subject to NI 81-102 and National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101); and

ii.             the prohibition contained in paragraph 2.5(2)(c) of NI 81-102 against a mutual fund investing in another mutual fund’s securities where those securities are not qualified for distribution in the local jurisdiction

(together with paragraph (i) above, the Exemption Sought),

to permit each Top Fund to invest up to 10% of its net asset value, taken at market value at the time of the investment, in units of the Underlying Alternative Funds (as defined below).

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):

(a)           the Ontario Securities Commission is the principal regulator for the application; and

(b)           the Filer has provided notice that Section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island, Quebec, Saskatchewan and Yukon (together with Ontario, the Jurisdictions).

Interpretation

Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined. The following term shall have the following meaning:

Underlying Alternative Funds means BMO AM Global Absolute Return Bond Fund and BMO AM Market Neutral Global Equity Fund.

Representations

This decision is based on the following facts represented by the Filer:

The Filer

1.             BMO AM is a corporation with its head office located in Toronto, Ontario.

2.             BMO AM is registered as an investment fund manager in each of Ontario, Québec and Newfoundland and Labrador, as an exempt market dealer and a portfolio manager in each of the Jurisdictions and as a commodity trading manager in Ontario.

3.             The Filer is not in default of securities legislation in any of the Jurisdictions.

4.             The Filer is, or will be, the manager of each Top Fund and each Underlying Alternative Fund.

The Top Funds

5.             Each Top Fund is, or will be, a “mutual fund”, as such term is defined under the Securities Act (Ontario) (the Act).

6.             Each Top Fund has, or will have, a simplified prospectus, annual information form and fund facts document prepared in accordance with NI 81-101 or a prospectus prepared in accordance with National Instrument 41-101 General Prospectus Requirements, and securities of each Top Fund are, or will be, qualified for distribution in the Jurisdictions.

7.             Each Top Fund is, or will be, a reporting issuer under the securities legislation of one or more Jurisdictions and is, or will be, subject to NI 81-102.

8.             None of the existing Top Funds is in default of securities legislation in any of the Jurisdictions.

9.             The Top Funds are, or will be, asset allocation funds whose investment objectives and strategies allow, or will allow, them to invest, directly or indirectly, in fixed income securities and/or equity securities and, as part of this asset allocation strategy, permit them to invest in securities of other mutual funds.

10.          The investment objectives and strategies of each Top Fund permit the Top Fund to invest in units of the Underlying Alternative Funds, subject to being granted the Exemption Sought. Each Initial Top Fund has a specific target allocation to each of the asset classes in which the Underlying Alternative Funds primarily invest.

The Underlying Alternative Funds

11.          The Underlying Alternative Funds are each a “mutual fund”, as such term is defined under the Act, formed as a trust under the laws of Ontario pursuant to a declaration of trust.

12.          The Underlying Alternative Funds are not reporting issuers in any of the Jurisdictions and are not therefore subject to NI 81-102.

13.          Units of the Underlying Alternative Funds are available for purchase only by investors that qualify to invest in the Underlying Alternative Funds pursuant to an exemption from the prospectus requirement, such as those that meet the definition of an “accredited investor” as set forth in National Instrument 45-106 Prospectus Exemptions and/or the Act.

14.          The investment objective of BMO AM Global Absolute Return Bond Fund is to deliver a return through a combination of income and capital growth irrespective of market conditions by investing primarily in fixed income instruments from across the global fixed income universe. BMO AM Global Absolute Return Bond Fund invests primarily in a globally diversified multi-sector portfolio of fixed income instruments. It will typically have at least two thirds of its total assets invested in corporate bonds, with the remaining allocated amongst non-corporate bonds. It may use financial derivative instruments for hedging investment risk, reducing the impact of volatility on the fund and for investment purposes. Synthetic long positions and synthetic short positions may be taken through these financial derivatives instruments. Its strategies include the use of specified derivatives to provide leveraged investments.

15.          The investment objective of BMO AM Market Neutral Global Equity Fund is to deliver capital growth, over the medium term by employing a global long/short market neutral equity strategy. BMO AM Market Neutral Global Equity Fund implements a long/short strategy by investing in specified derivatives on customised baskets of global equity securities. It invests primarily in a portfolio of high quality, short dated government bonds, cash OTC total return swaps and currency forwards. Its strategies include the use of specified derivatives to provide leveraged investments.

Investments in BMO AM Global Absolute Return Bond Fund

16.          An investment by the Top Funds in BMO AM Global Absolute Return Bond Fund will be compatible with the investment objectives and strategies of those Top Funds that desire income and capital growth through investments in global fixed income securities.

17.          The Filer believes that an investment in BMO AM Global Absolute Return Bond Fund will provide an efficient and cost effective way for the Top Funds to achieve diversification and maximize absolute returns while seeking to remove market risk. Allowing the Top Funds to invest in units of BMO AM Global Absolute Return Bond Fund will also allow them to leverage the expertise, research and investment style of the sub-advisor to BMO AM Global Absolute Return Bond Fund.

18.          While it may be possible for the Top Funds to invest in other global fixed income products that deliver returns through income and capital growth, the Filer believes it is in the best interests of the Top Funds to have the ability to invest in BMO AM Global Absolute Return Bond Fund because the alternatives available to the Filer are not optimal relative to investing in BMO AM Global Absolute Return Bond Fund. BMO AM Global Absolute Return Bond Fund seeks to deliver returns irrespective of market conditions by using derivatives to move the portfolio in the opposite direction of the market when there is volatility. Further, the Filer has gained comfort with the portfolio management approach used by its affiliated sub-advisor for BMO AM Global Absolute Return Bond Fund and prefers it over any peers in the marketplace.

Investments in BMO AM Market Neutral Global Equity Fund

19.          An investment by the Top Funds in BMO AM Market Neutral Global Equity Fund will be compatible with the investment objectives and strategies of those Top Funds that desire capital growth through investments in global equity securities.

20.          The Filer believes that an investment in BMO AM Market Neutral Global Equity Fund will provide an efficient and cost effective way for the Top Funds to achieve diversification and maximize absolute returns while seeking to remove market risk. Allowing the Top Funds to invest in units of BMO AM Market Neutral Global Equity Fund will also allow them to leverage the expertise, research and investment style of the sub-advisor to BMO AM Market Neutral Global Equity Fund.

21.          While it may be possible for the Top Funds to invest in other global equity products that deliver returns through capital growth, the Filer believes it is in the best interests of the Top Funds to have the ability to invest in BMO AM Market Neutral Global Equity Fund because the alternatives available to the Filer are not optimal relative to investing in BMO AM Market Neutral Global Equity Fund. BMO AM Market Neutral Global Equity Fund seeks to deliver returns irrespective of market conditions by using derivatives to hedge away market risk. Further, the Filer has gained comfort with the portfolio management approach used by its affiliated sub-advisor for BMO AM Market Neutral Global Equity Fund and prefers it over any peers in the marketplace.

General

22.          The Underlying Alternative Funds are managed by BMO AM and sub-advised by an affiliated sub-advisor of BMO AM. Accordingly, the Filer will benefit from a close understanding of the investment style and approach of the portfolio manager of the Underlying Alternative Funds, thereby benefiting the Top Funds.

23.          The Underlying Alternative Funds are managed in compliance with Parts 2, 4 and 6 of NI 81-102, except for sections 2.7(1), 2.7(2), 2.7(3) and 2.8 relating to transactions in specified derivatives.

24.          The Underlying Alternative Funds will comply with the restrictions relating to illiquid assets (section 2.4 of NI 81-102) and investments in other investment funds (section 2.5 of NI 81-102) for so long as they are held by one of the Top Funds.

25.          The portfolio of each Underlying Alternative Fund consists primarily of publicly traded securities. Each Underlying Alternative Fund does not hold more than 10% of its net asset value in illiquid assets (as defined in NI 81-102).

26.          In September 2016, the Canadian Securities Administrators published CSA Notice and Request for Comment – Modernization of Investment Fund Product Regulation – Alternative Funds (the Alternative Funds Proposal). The Alternative Funds Proposal proposes to permit conventional mutual funds to invest up to 10% of their net assets in securities of alternative funds and non-redeemable investment funds, provided those alternative funds are subject to NI 81-102 (as it is proposed to be amended by the Alternative Funds Proposal).

27.          The Underlying Alternative Funds are currently managed in compliance with the proposed investment restrictions applicable to alternative funds set out in the Alternative Funds Proposal, except for the proposed restrictions relating to leverage. The Underlying Alternative Funds’ use of specified derivatives to achieve leveraged investment exposure conforms with the limits in this decision. Upon the coming into force of the final rule implementing the Alternative Funds Proposal (the Alternative Funds Rule), the Underlying Alternative Funds’ use of leverage will comply with the finalized version of such requirements for so long as securities of the Underlying Alternatives Funds are held by the Top Funds.

28.          The Underlying Alternative Funds comply with National Instrument 81-106 Investment Fund Continuous Disclosure (NI 81-106), except for Parts 4 and 6.

29.          Securities of the Underlying Alternative Funds are valued and redeemable on the same dates as securities of the Top Funds. An investment by a Top Fund in an Underlying Alternative Fund will be effected based on the Underlying Alternative Fund’s net asset value, which is calculated in accordance with Part 14 of NI 81-106.

30.          Pursuant to a decision dated January 13, 2009, the Filer obtained exemptive relief from section 2.5(2)(a) of NI 81-102 that permits each Top Fund to invest up to 10% of its net asset value in securities of exchange-traded funds managed by BetaPro Management Inc. that are “commodity pools” as defined in National Instrument 81-104 Commodity Pools (Underlying ETFs). The Underlying ETFs meet the definition of “alternative fund” in the Alternative Funds Proposal. Each Top Fund will reduce its maximum permitted exposure to the Underlying Alternative Funds by the amount of any investment in the Underlying ETFs.

31.          A Top Fund will not invest in an Underlying Alternative Fund, an “alternative fund” (as defined in the Alternative Funds Proposal, as may be modified by the Alternative Funds Rule), or a non-redeemable investment fund if, immediately after the investment, more than 10% of the Top Fund’s net asset value, in aggregate, taken at market value at the time of the investment, would consist of investments in (i) the Underlying Alternative Funds; (ii) “alternative funds” (as defined in the Alternative Funds Proposal, as may be modified by the Alternative Funds Rule), and (iii) non-redeemable investment funds.

32.          Other than the Exemption Sought, the Top Funds will comply fully with section 2.5 of NI 81-102 in their investments in the Underlying Alternative Funds and the simplified prospectus of the Top Funds will provide all applicable disclosure mandated for mutual funds investing in other mutual funds.

33.          Where applicable, a Top Fund’s investment in an Underlying Alternative Fund will be disclosed to investors in such Top Fund’s quarterly portfolio holding reports, financial statements and fund facts and/or ETF facts documents.

34.          Upon request, the Filer will make available copies of the offering memorandum and declaration of trust, as applicable, of the Underlying Alternative Funds to investors of the Top Funds.

Decision

The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.

The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:

(a)           for so long as an Underlying Alternative Fund is held by a Top Fund, the Underlying Alternative Fund complies with the following investment restrictions:

(i)            Part 2 of NI 81-102, except for sections 2.7(1), 2.7(2), 2.7(3) and 2.8 of NI 81-102;

(ii)           the Underlying Alternative Fund’s aggregate gross exposure, calculated as the sum of the following, must not exceed three times the Underlying Alternative Fund’s net asset value: (A) the aggregate market value of the Underlying Alternative Fund’s long positions; (B) the aggregate market value of securities sold short by the Underlying Alternative Fund; and (C) the aggregate notional value of the Underlying Alternative Fund’s specified derivatives positions, excluding any specified derivatives used for “hedging” purposes, as defined in NI 81-102;

(iii)           in determining the Underlying Alternative Fund’s compliance with the restriction contained in (a)(ii) above, the Underlying Alternative Fund must also include in its calculation its proportionate shares of securities of any underlying investment funds for which a similar calculation is required;

(iv)          the Underlying Alternative Fund must determine its compliance with the restriction contained in (a)(ii) above, as of the close of business of each day on which the Underlying Alternative Fund calculates a net asset value; and

(v)           if the Underlying Alternative Fund’s aggregate gross exposure, as determined in subsection (a)(ii) above, exceeds three times the Underlying Alternative Fund’s net asset value, the Underlying Alternative Fund must, as quickly as is commercially reasonable, take all necessary steps to reduce the aggregate gross exposure to three times the Underlying Alternative Fund’s net asset value or less;

(b)           each Underlying Alternative Fund complies with Parts 4 and 6 of NI 81-102 and Part 14 of NI 81-106;

(c)           the prospectus of a Top Fund discloses, or will disclose in the next renewal or amendment thereto following the date of this decision, the fact that the Top Fund has obtained relief to invest in the Underlying Alternative Funds, which are alternative funds managed by the Filer that are not reporting issuers, and any material risks associated with investing in the Underlying Alternative Funds;

(d)           a Top Fund will not invest in an Underlying Alternative Fund, an “alternative fund” (as defined in the Alternative Funds Proposal, as may be modified by the Alternative Funds Rule) or a non-redeemable investment fund if, immediately after the investment, more than 10% of the Top Fund’s net asset value, in aggregate, taken at market value at the time of the investment, would consist of investments in (i) the Underlying Alternative Funds, (ii) “alternative funds” (as defined in the Alternative Funds Proposal, as may be modified by the Alternative Funds Rule), and (iii) non-redeemable investment funds; and

(e)           upon the coming into force of the Alternative Funds Rule

(i)            the conditions in paragraph (a) above will cease to apply; and

(ii)           each Underlying Alternative Fund will comply with the provisions of Part 2 of NI 81-102 that are applicable to an “alternative fund” (as such term is defined in the Alternative Funds Rule) for so long as such Underlying Alternative Fund is held by one of the Top Funds.

“Darren McKall”
Manager
Investment Funds and Structured Products Branch
Ontario Securities Commission