Mark Gillan, Head of Product at AJ Bell.

The world of alternative, illiquid assets has often been seen as reserved for institutional and sophisticated professional investors. Broadening access to these investments to the retail market, however, is a topic that is steadily moving toward the top of the agenda for regulators and asset managers.

There are several trends driving this change in outlook. To provide a sufficiently diversified portfolio for long-term investors, such as those in pension schemes, there is an increasing desire to add illiquid assets into the mix and tap into the additional potential returns brought about by their inclusion.

Also, with governments around the world focusing on ‘building back better’ following the worst of the coronavirus pandemic, there is political motivation to work with investment industry to encourage long-term ‘patient capital’ and finance large-scale projects such as infrastructure and green initiatives.  

The challenge now is for the various stakeholders to work together and devise a solution that allows retail investors to access the illiquidity premium, in a way where risk is managed effectively, which is deliverable operationally and works from a commercial perspective for providers.

“The challenge now is for the various stakeholders to work together and devise a solution that allows retail investors to access the illiquidity premium”

There are already various potential options available such as the European Social Entrepreneurship Fund (EuSEF), European Venture Capital Fund (EuVECA) and European Long-Term Investment Fund (ELTIF). However, these have not been met with great success given that they are aimed primarily at professional investors rather than retail customers or have fairly restrictive investment powers.  

There is also the Investment Trust structure in the UK, which is often seen as suitable for patient capital investment.

However, many investors such as pension schemes prefer an open-ended structure, as a closed-ended vehicle may give an equity-style return profile, minimising the diversification benefits.

Other investors will prefer the ability to purchase and redeem at the net asset value of the underlying assets rather than accounting for a premium/discount mechanism used by an Investment Trust.  

“The LTAF will be open-ended and have investment powers that will allow a variety of asset classes to be included”

To address the gap for retail investment in illiquid assets, regulators are looking at brand new fund structures. One of the most promising is the Long-Term Asset Fund (LTAF) in the UK. The FCA has recently launched a consultation into this, describing the fund as:

“…able to invest in assets such as venture capital, private equity, private debt, real estate and infrastructure, often referred to as productive finance. The aim of this new long-term asset fund (LTAF) would be to provide a fund structure through which investors can invest with appropriate confidence in less liquid assets because the fund structure is specifically designed to accommodate relatively illiquid assets.”[1]

The LTAF will be open-ended and have investment powers that will allow a variety of asset classes to be included.

Commercially there is a gap in the market for asset managers to fill, and a strong incentive and demand from retail investors to access illiquid investments.

“There are some interesting operational and distribution challenges that will need to be overcome in order to make any new structure a success”

Regulators, recognising this, are keen to move quickly, with the FCA aiming to launch the LTAF by the end of 2021. There are however, some interesting operational and distribution challenges that will need to be overcome in order to make any new structure a success.

• The proposed fund will allow flexible dealing frequencies, to align the subscription and redemption opportunities with the underlying assets in the fund. There is also the possibility of introducing notice periods – potentially 180 days or longer – to manage liquidity risk.

This may present issues around trade processing and risk management. Many fund managers, platforms and custodians can handle non-daily dealing and pricing however unusual dealing frequencies, notice periods and other complex arrangements such as side pockets or deferred settlement could mean amendments to processes, manual intervention, and IT development to build queuing systems for redemptions and ringfence client cash.

• The nature of the underlying assets means that robust and timely valuation and pricing may be difficult, with new data sources and reconciliation processes required, including a need for external valuation if the manager cannot demonstrate the ability to do this itself.
• Additional reporting, disclosures and governance obligations will be needed, to demonstrate how valuations have been arrived at and how liquidity has been managed effectively. Amendments will also be required to the standard templates for documentation such as the prospectus.
• With the fund structure being viewed as non-standard, it’s quite possible that they may not be eligible for certain wrappers such as ISAs and SIPPs, limiting distribution potential. Even for taxable wrappers, long notice periods can make Capital Gains Tax planning a minefield. This may make distribution trickier than with more widely-available products.
• Asset transfers between custodians, already a complex and manual area, could be made more difficult with the addition of instruments with substantial notice periods.
• For investment managers, holding LTAFs within a multi-asset fund or model portfolio structure could be problematic as they will not fit neatly with a regular rebalancing frequency.

Despite these challenges, broadening the audience for alternative, illiquid investment has many benefits for investors, asset managers and society as a whole.

Whilst the initiatives under discussion may not yet bring alternative investment to a true retail mass market, they are an important step in the right direction. Operational teams will need to monitor developments closely and be prepared to adapt to any new fund structures to meet customer demand.

[1] FCA launches consultation on a new type of fund to support investment in long-term assets | FCA

 

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