Key Feature 1: Limited Secondary Market
The primary market and secondary markets differ considerably. The primary market is like buying a watch from a retailer whereas the secondary market is like buying it second hand from the previous owner. Where public and private markets differ is a secondary market is where buyers and sellers can transact investments, generally facilitated in a stock exchange. Stock markets act as the facilitator, just as e-bay facilitates secondary transactions. The Exempt Market does not have an easy way to buy and sell an investment ‘used.’ Therefore, it is termed illiquid, meaning that there is limited opportunity to sell the investment once it is bought. The effect to this is that Exempt Market investments do not have what is called market risk, or do not fluctuate in value on a day to day basis based on market trends or emotion. Alternatively, it is very difficult, often impossible, to sell Exempt Market investments if your circumstances change.
Key Feature 2: Limited Liquidity
A general lack of liquidity makes investing in Exempt Market investments materially different from more widely available investments like; public stocks, bonds, derivatives, or mutual funds. It means that that you generally cannot get your money out of an Exempt Market investment on demand, so you have to be sure that the money you invested will not be needed for the time frame specified (or longer) and that the investment fits to goals of your overall financial plan. Generally, similar to a locked in investment, the investment must mature before you can get your cash (and earnings) back. The benefit of illiquidity is that it helps you to stay on track with your savings plan over the long term, as you cannot redeem your investments on a whim. In general, investors are offered greater returns on their money when faced with this liquidity risk. However, the quality of Exempt Market investments varies greatly, just like in the public markets. Some investments are structured with redemption options and partial liquidity on a ‘best efforts’ basis. A way to mitigate the liquidity risk in your portfolio is to match the investments to your investment goals with longer timelines.
Key Feature 3: Limited Ongoing Information
Unlike a company listed on a public stock exchange, which provides ongoing financial information to the public via www.sedar.com, most companies that raise capital in the exempt market are not required by law to provide ongoing information to investors. Some companies that utilize the exempt market do provide this information voluntarily or as a mandate set by an Exempt Market Dealer, however that is not always the case. This lack of information can make investors nervous. Investors need to understand the type of information they will be provided on an ongoing basis by the companies in which they intend on investing and ensure what is provided meets their comfort level.
Key Feature 4: Valuation Limitations
Another distinguishing feature of Exempt Market investments is that it is not always easy to determine what a given investment is worth at a particular point in time. Quick valuation through the secondary market of market value assessments like stock quotes or unit values are absent. This can make investors nervous. Even experienced investors that go into a ten year deal can get hot feet not knowing the realistic market value five years in. If calculated, a net asset value (NAV) estimate can be useful in determining your investment’s value and can be based on robust measures, but it still is no replacement for a market value. A benefit to this is that you do not have to see continuous value fluctuations of your investments due to the business cycle, but you have to make sure you are steadfast enough to be somewhat in the dark. Having said this, the general lack of liquidity of Exempt Market products makes ongoing valuations less meaningful given that the investments generally have no marketability.
Key Feature 5: There are Risks
In the Exempt Market, there are a range of types of investments and risks associated with those investments. Exempt market investments are generally based on real business initiatives and businesses can fail. In general, the risks in the exempt market are higher, namely due to liquidity risk and business risk. However, risks that generally are absent from these types of investments are inflation risk in GICs, and market risk stocks and mutual funds. Even a savings account at the bank earning 1% has risk, as the money is devalued over time with inflation. Every investment has risk. It is important for you to know the risks and the potential downsides before investing in any investment product.