The UK is due to launch a new type of vehicle, the long-term asset fund or LTAF, to help retail investors access private and illiquid assets, such as private debt. The government and regulators spy an opportunity to achieve several of their key objectives in one fell swoop. Consequently, the Chancellor of the Exchequer, Rishi Sunak, has set an aggressive timeline to have the first LTAF launched in the market by the end of this year.
The Woodford Investment Management debacle shone a light on an oddity of the UK’s fund regime: managers can offer their investors daily liquidity in open-end funds despite being invested in highly illiquid assets such as real estate. Regulators have struggled to define how funds’ redemption terms can be properly aligned with the managers’ ability to sell their holdings.
At the same time, the government is keen to drive more retail investment into these same illiquid, often private market, assets. As the UK emerges from Brexit and covid, the government has ambitious aims to ‘level up’ economic growth across the country, increasing investment in infrastructure, property and debt, all the while ‘building back greener’. Directing the large amounts of capital sitting in defined contribution pension pots towards these longer-term asset classes has long been the holy grail for policymakers. The LTAF appears to be a rare example of a single policy that could help achieve all these objectives.
Funds of distinction
LTAFs will have a distinguishing feature among the UK’s authorised fund range. They will not be dealing daily but will rather give managers the discretion to align the funds’ dealing and redemption opportunities with the liquidity of the underlying assets. For example, in the case of a private debt strategy, managers might choose quarterly or annual redemption opportunities to allow time to manage the flow of capital into and out of the fund. At the same time, investors would have clarity about what their fund is invested in and when they can get their money back. ‘No more Woodfords’ is the regulator’s aim.
Unlike the existing types of fund that can be marketed to retail investors, the LTAF will have far fewer restrictions on its eligible investments. Infrastructure, private debt and private equity are all within the scope. Given the fund’s flexibility, it is possible to imagine a variety of LTAFs emerging, some more niche than others. Covid recovery funds to support indebted businesses, general infrastructure vehicles and a variety of ESG-themed schemes are all conceivable under the LTAF banner.
Who will buy LTAFs? Regulators will be cautious about firms allowing LTAFs to be sold to mass-market, unadvised investors. The LTAF structure allays some of the regulators’ fears about Woodford 2.0. Nevertheless, the LTAF still differs from vanilla mutual funds in its structure and underlying assets. Investors will be expected to understand those features or to rely on a trusted intermediary that can act on their behalf.
The primary target audience for the LTAF is UK defined contribution pensions. These workplace schemes have a steady flow of monthly contributions from their scheme members and a lot of money tied up for a long time. This so-called patient capital is ideal for the type of long-term investment that the government desires. Some pension schemes are already increasing their investments in private assets. For instance, the largest scheme, the government-established NEST, intends to increase its investment in private assets from 9 percent to 15 percent of its total portfolio. The average UK DC scheme has around 5 percent of investments in private assets. The LTAF’s introduction could facilitate DC schemes’ growing demand for illiquids.
The second key constituency for the LTAF is wealth management. Private banks and wealth managers have a sophisticated client base, eager to explore new investment opportunities and achieve greater returns. Some wealth management clients are classified as professional or semi-professional investors and therefore have few constraints on their ability to put their money wherever they choose. However, despite their relative sophistication, many wealth management clients are classified as retail investors for regulatory purposes. The LTAF should give wealth managers the opportunity to diversity their retail clients’ portfolios, secure in the knowledge that their recommended investment vehicle is suitable.
The benefits of ‘retailisation’ to issuing firms are clear: the ability to diversify their sources of funding and potentially reduce their funding costs by expanding supply. Meanwhile, managers, investors and their advisors spot opportunities to gain greater yield – no trivial thing in an age of chronically low
Yet some will reasonably ask why the LTAF is necessary. Are there not enough fund types for private and illiquid investments, and even some vehicles that are viable for retail investors?
“The EU is undertaking a review of ELTIF legislation and it is both possible and desirable for the ELTIF to become more attractive. But for now, the LTAF could offer a credible alternative”
Existing retail investment funds, whether UCITS or non-UCITS retail schemes, are subject to strict regulations that restrict the extent to which they can invest in illiquid and private assets. There are authorised funds, such as the QIS, and a range of unauthorised vehicles that can invest in these assets in a much freer way. However, regulators will only permit professional investors to invest in these funds.
Investment trusts – which, despite their name, are investment companies rather than trusts – can invest in private assets on behalf of retail investors. However, investment trusts are closed-end funds, which means they trade at market value rather than at the value of their underlying assets. The equity-like features of these funds can, for example, dissuade those that wish to invest in private debt, by not giving them the confidence that they will be able to redeem their funds at a value equivalent to that of their investments. The LTAF, on the other hand, is an open-end structure that would trade at net asset value.
The final contender is the European long-term investment fund. Unfortunately, ELTIFs have failed to take off, with fewer than 30 currently in the market since the EU launched the fund wrapper in 2015. This is largely due to the ELTIF’s design, which includes restrictions on the vehicle’s ability to invest in other funds. Fund-of-funds are important means by which managers can achieve diversification of their investments. The LTAF will have few restrictions on its ability to do this. Furthermore, the LTAF will be able to invest globally, while the ELTIF is largely restricted to European investments. The EU is undertaking a review of ELTIF legislation and it is both possible and desirable for the ELTIF to become more attractive. But, for now, the LTAF could offer a credible alternative.
There are several issues to resolve before the LTAF is launched. The UK’s Financial Conduct Authority is due to consult soon on the detailed features of the regime, and the Treasury is probing its tax treatment. DC schemes, used to offering daily dealing funds on their platforms, will need to become operationally prepared to offer LTAFs to their members.
The rush to launch the first LTAF before 2022 risks mistakes being made. As we have seen with the ELTIF, poorly crafted regulations can cripple a fund launch and potentially undermine its attractiveness for good. The LTAF needs credibility from the outset. Most importantly, it must be seen to be a vehicle that is right for retail investors, that is safe to invest in and that offers genuine opportunities to access attractive private investments.
Lora Froud is a partner and Gavin Haran is head of policy for asset management at law firm Macfarlanes in London