The Long Term Asset Fund (LTAF) regime came into effect on 15 November last year with its investment approach clearly defined by the Financial Conduct Authority (FCA). At least 50 per cent of LTAF open-ended funds must be invested in assets that are long term in nature and illiquid, or in other funds that invest in such assets. Further, the funds must have restrictive redemption terms and the phrase Long Term Asset Fund or LTAF must be included in the fund’s name.
The new regime’s primary impact is that it will enable DC pension schemes to access the alternative assets classes of private equity, private debt, infrastructure and real estate. A point emphasised by Aegon pensions director Steve Cameron: “LTAFs are a key stage in the critical path towards DC pensions investing more in illiquids.”
Historically, DC providers have been deterred from putting capital to work in alternatives by the need to preserve daily liquidity. Traditional open-ended funds typically offer daily pricing based on the net asset value (NAV) of holdings, but this creates a liquidity mismatch when investing in illiquid assets.
As the manager buys and sells shares in open-ended funds directly to investors, the fund must have enough cash to meet their redemption demands. However, the illiquid nature of alternatives means managers may not be able to liquidate the invested capital quickly enough. The redemption restrictions of the LTAF regime are designed to work around this problem.
The 2016 Brexit referendum brought the illiquidity problem into sharp focus. When investors tried to take substantial redemptions, notably in real estate, asset managers were forced to suspend dealing in the worst-hit funds. The alternative would have been to undertake a fire sale of properties in the portfolio to repay all the investors that wanted out, which would have impacted all remaining investors.
However, the attractive returns delivered by alternatives in recent years is now considered an opportunity to decorrelate portfolios from the mainstream asset classes of equities and bonds, and one of the key reasons why the FCA has authorised the new structure for DC pensions.
Globally, private equity and venture capital have outperformed the total returns of the US S&P 500 over the last decade, according to Preqin, with the difference particularly notable since 2019 (see chart ). Likewise, private debt, infrastructure and realestate have produced steady attractive returns.
Investors have certainly taken note. Total private markets fundraising – private equity, private debt, real estate, infrastructure and agriculture – has increased steadily since the global financial crisis, from $356.8bn in 2009 to $1,211.2bn in 2021, according to PEI (see chart).
Approaching with caution
LTAFs have received a cautious welcome from DC pension providers and consultants.
“We shouldn’t expect to see a sudden rush into alternatives by schemes – it will be more evolution rather than revolution,” says Aegon’s Cameron. Although the new regime paves the way for alternatives, investors will still be left with illiquidity and other challenges, including relatively
high fees.
In fact, the FCA itself is restricting access to LTAFs, at least initially, to DC default funds. This means they will not, for now anyway, be available to self-select pension investors. “The FCA is nervous about LTAFs being used inappropriately. You have to trade them very carefully… and within the notice periods,” says Lane Clark and Peacock (LCP) partner, DC investment consulting Stephen Budge.
To qualify as an LTAF a product must offer a redemption window no more frequently than once a month. It must also have a notice period of at least 90 days, although it is likely that many LTAFs will have considerably longer notice periods.
The FCA states:“The introduction of the LTAF should help facilitate an environment where investors that wish to invest in productive finance assets can do so. Our new rules embed
longer redemption periods, high levels of disclosure, and strong liquidity management and governance features.”
LTAFs are also being made available to high-net-worth individuals and sophisticated retail investors, but not to the general retail market. They are classified as a non-mainstream pooled investment.
Closed-end competition
Investors don’t have to go down the route of the new LTAF open-ended regime, of course. They can still access illiquid and unlisted assets by one very well-established means – closed-ended funds. In the UK, this often means investment trusts (ITs).
ITs might appear to offer the ideal solution for investing in illiquid assets. There is no redemption problem because the fund is listed on a stock exchange. Anyone selling shares in the fund does so to other investors on the exchange (not back to the fund manager) so the capital stays invested.
However, an IT’s price on the stock exchange is likely to be different from the underlying value, at a discount or premium to NAV. Some investors are not comfortable paying a premium or experiencing a discount when they’re entering or exiting, notes IA director, policy and research Jonathan Lipkin. “They’re looking for a return that is more closely aligned with the underlying assets, as opposed to the value ascribed to it in the market,” he says.
“We don’t see this as a race between the open-ended and closed-ended worlds,” says Lipkin. “We are not suggesting that investment funds are superior to ITs. We take the view that there is an important role for both.” LTAFs don’t “reinvent, but reimagine” the world of investing in illiquids, he adds.
Investors can also buy into a wide range of private equity, infrastructure and other funds provided by the likes of HgCapital Trust, Pantheon and 3i. Hg Capital, established in 1989, focuses on private equity in the technology sector, for example, and its investors have more than doubled their money in the last three years.
Barriers to progress
There is one potential stumbling block to investing in LTAF products – the alternative assets they will typically invest in mean they would likely be among the most expensive components of a DC portfolio.
The management fee alone might be around 120 basis points, say consultants we spoke to. However, this should be seen in the context of the higher returns illiquid assets tend to deliver (the overall return after fees is the most important metric).
Redington head of DC and financial wellbeing Jonathan Parker says: “Trustees need to think about overall suitability for members of including an allocation to these asset classes. For example, whether the potentially higher cost makes sense.”
However, LTAFs are only likely to account for 10-15 per cent of a DC default fund. If LTAFs are combined with passive and other low-fee funds, providers should be able to remain below the default fund fee cap of 75 basis points.
Consultants and pension providers are positive about the prospects for LTAFs, but the optimism is qualified. “We are seeing promising signs that the LTAF will lead to an increase in private market choices in UK DC default design,” Budge says. “However, we already have clients invested in private market offerings and, as such, the LTAF is an additional option rather than the only option for client investment.”
Aegon’s Cameron also cautioned against the prospects of LTAFs driving a dramatic shift towards long-term assets. He says the long notice periods and redemption restrictions are a barrier. “Members of DC pension schemes now fully expect their pension funds to be priced daily and to be able to switch funds, transfer between schemes or, from the age of 55, access their pensions flexibly, all without any delay or notice period.
“LTAFs will have notice periods of various lengths and the underlying assets won’t have daily prices, with redemptions no more frequently than monthly. It’s unlikely we’ll see any immediate move towards a greater proportion of capital in long-term UK assets.”
As the LTAF regulations only took effect in November, Budge says the authorisation process means the first funds would not formally launch until the second or third quarter of this year.
ESG benefits
LTAFs have one other potential key strength – they play to investors’ and the government’s sustainability goals. The long-term nature of some renewable energy projects, for example, means that the LTAF regime could, in a limited way, help the UK government deliver net-zero emissions by 2050, as well as address other aspects of the ESG agenda.
“While the LTAF is not specific to net zero, it’s likely to be a common feature,” says LCP’s Budge. “The managers we have discussed new fund launches with are, in the main, also including a net zero or responsible investment overlay in their process or allocation.”
