The Financial Conduct Authority (FCA) has launched an open-ended investment fund structure to enable more access to long-term illiquid assets.
Long-term asset funds (LTAF) are specifically designed for investment into illiquid assets such as venture capital, private equity, private debt, real estate and infrastructure.
The LTAFs will come into force on November 15th and will initially be available to sophisticated and high-net-worth investors for use in their defined contribution (DC) pension schemes.
One of the key factors to these funds is that investors must give a minimum 90-day notice period for withdrawals. This addresses the mismatch between redemption terms and the liquidity of some of the funds’ assets, something that the Bank of England had previously identified could “create a potential systematic risk”.
This has been brought to light by the open-ended property sector, where most funds were forced to suspend dealing as withdrawals piled in quicker than the portfolios could sell their properties to realise cash and pay back their investors.
The FCA said in the report: “There will be a minimum 90-day notice period for withdrawals. Without it, some long-term projects with good potential returns may not happen.”
Reaction from the industry has been varied, however. Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said that investing in illiquid assets offered a “huge opportunity” for investors to boost their pension pots, but added if this structure was to work it was critical that investors fully understood what they were investing in and what their rights were.
Morrissey added that she welcomed the FCA’s decision to put some time between the initial rollout and expanding it to other retail investors, saying “it is important to take the time to get this right”.
Laith Khalaf, head of investment analysis at AJ Bell, said that he expected property funds would follow suit on the 90-day redemption period.
He noted that the FCA’s plans for the open-ended property sector were absent from the announcement, but that data from the Investment Association (IA) found that the UK Direct Property sector had more than halved in two years, from £20.1bn in September 2018 to £9.1bn today.
The product would address the institutional market primarily, but Khalaf noted that this is not a part of the market where long-notice periods have previously been an issue.
“It’s likely that mandatory notice periods would lead to further outflows, and seriously undermine the viability of the open-ended property sector going forward,” the analyst said.
“The FCA has now provided the regulatory framework for such funds, but the asset management industry still needs to build successful products at a reasonable price.”
Richard Stone, chief executive of the Association of Investment Companies (AIC), said his main fear was the 90-day redemption period not being long enough, particularly in periods of “stressed markets.
“If too short, this could threaten the long-term resilience of the LTAF,” he said, noting that it will be a tough challenge for managers to set suitable notice periods, especially if the structure itself incorporates leverage.
“It is difficult to see how investors can be assured there won’t be a run on an LTAF’s liquidity when market sentiment turns negative,” Stone said.
Kyle Caldwell, collectives specialist at interactive investor (II), agreed with Stone, noting that “90 days is no time at all in a liquidity crisis”.
The firm also questioned why wealthy investors were being warranted special treatment, while adding there were concerns that there were already talks of opening this out to wider retail investors.
Indeed Caldwell said that although the LTAF idea is sensible, it is untested and does not address how the new structure gets around the existing shortcomings of open-ended funds investing in illiquid assets.
He said it was a “halfway house between open-ended funds in their current form and an investment trust, as they are seeking to limit daily withdrawals, but without putting a limit on how much can be invested on a daily basis”.
He added that investment trusts remained a safer and more logical way for retail investors to gain access to illiquid assets.
Nikhil Rathi, chief executive of the FCA, said: “If this innovative fund structure, created by our rules, is taken up by the asset management industry, it may provide alternative routes to returns for investors, while supporting economic growth and the transition to a low carbon economy.”