PRIVATE EQUITY IN CANADA is expected to have a banner year in 2016, a new report from Toronto-based law firm Torys LLP predicts. As a result, the retail mutual fund sector is likely to be in for a rocky ride.

“Good news in one usually means bad news in another,” says Michael Akkawi, partner and head of Torys’ private equity group in Toronto, and co-author of Private Equity in Focus, 2016.

Specifically, the relative pricing of Canadian assets, accessible leverage markets and a weak Canadian dollar are driving the move toward private equity, he says: “The macro environment in Canada is leading investors into private equity and other alternative investments, where [investors] believe they can get a better return on investment.”

Upheavals and uncertainty in the public market also are prompting investors to look elsewhere – and investors are more likely to continue to focus on private equity and other alternative investments in 2016, says Akkawi: “It seems there will be an intense amount of focus on any good deals offered in the [private equity] market.”

The 2016 edition of the Torys annual report, the second produced by the law firm, suggests that private equity will be distinguished by a competitive deal environment this year, particularly from two key contenders: pension funds and other strategic buyers. In 2015, strategic sales accounted for the majority of private-equity activity, representing 58% of domestic mergers and acquisitions (M&A) transactions involving finance-related players.

M&As, which have been on the rise since 2013, continue to appeal to these investors as a way to pursue business growth. “Now,” says Akkawi, “pension funds are allocating more of their capital to alternative investments, including private equity.”

Foreign investors also have entered the ring. In the past year, the Torys’ report notes, foreign investment in the Canadian private-equity M&A market has grown, reversing a three-year decline since a peak in 2011. Roughly 40% of foreign investment activity in 2015 involved a foreign finance-related buyer, up from 34% in 2014.

Not surprising, the weaker Canadian dollar (C$), which will make foreign investments more costly for Canadians, is having the opposite effect in attracting foreign capital, Akkawi says: “The Canadian dollar may reduce activity in international markets. We will face more competition from foreign investors in Canada.”

The lower C$ is the result of a struggling energy sector – and the Torys report holds good news for this part of Canada’s economy. Although M&A activity in domestic energy dropped significantly in terms of the number of transactions in 2015, this trend is expected to reverse in 2016.

“Our view for this year is that the market has adjusted to a lower oil price. Capital budgets have already been adjusted,” says Akkawi. “We’re optimistic there will be a lot of activity in Alberta.”

Another significant change in the private-equity landscape comes from regulators. The Torys report, which devotes a section to this issue, states that increased scrutiny from regulators is culminating in greater transparency in the private-equity industry. More detailed and frequent disclosure of fees and expenses and more information and reporting regarding conflicts of interest and allocation policies are two examples of the shift in disclosure.

This trend is unlikely to abate on both sides of the Canada/U.S. border. The Torys report notes that U.S. regulators are signalling a need for private-equity funds to continue to improve disclosure – and investor advocacy groups are hard at work on a set of proposed industry standards regarding fee disclosure – so the pressure for enhanced transparency is expected to continue.

Much of this pressure stems from the U.S. Securities and Exchange Commission (SEC), which, the Torys report notes, now has a more complete picture of the private-equity business five years after the Dodd-Frank Act first required many portfolio managers to register and report their practices.

“In those five years, the SEC has gone from not knowing how many funds or managers exist to having insight into almost 30,000 private funds and 4,500 registered advisors,” the report states.

This insight resulted in some notable SEC enforcement actions in 2015, according to the Torys report. In August, for example, one portfolio-management firm agreed to pay US$20 million to settle charges that it had failed to disclose a US$50-million loan that a senior executive received from an investor. Then, in October, another firm agreed to pay US$39 million to settle charges of inadequate disclosure of accelerated monitoring fees and legal discounts the firm had received that were substantially higher than legal discounts received by the firm’s funds.

Despite the sophistication of institutional investors, the SEC has turned its attention to the private-equity market, Akkawi notes: “The SEC has said to a number of private-equity funds that they need to be more careful.”

The scrutiny and the cautions will be commonplace to portfolio managers and firms in the public market, he adds. “What has been the norm on the retail side is becoming more common on the private-equity side.”

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