With demand for alternatives and uncorrelated assets increasing in recent years, the Financial Conduct Authority has responded by offering a vehicle to access this area of the market — the LTAF.
Available since November 2021, the LTAF is an open-ended authorised fund structure that can invest in a full range of illiquid asset classes. This new fund structure is the UK's response to the EU's European Long-Term Investment fund (ELTIF).
Demand for the product has been very limited to date, however. LTAFs were originally restricted to professional investors, such as DC schemes, but reduced interest prompted a relaxation this year to allow a degree of retail access to the structure.
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In June, the financial regulator unveiled its final rules to allow mass market retail investors, self-select DC pension schemes and self-invested personal pensions (SIPPs) to invest into the LTAF.
The FCA's focus is to provide investors with access to long-term private assets such as private equity, infrastructure, private credit, venture capital and real estate, while ensuring that managers have proper regard for the vulnerability of retail investors.
The first LTAF developed for DC pensions was approved by the FCA for Schroders Capital in March. Aviva Investors and BlackRock have also received regulatory approval, taking the total number of LTAFs given the green light to four so far.
Opportunities
As companies stay private for longer, more investors are looking to enhance portfolio diversification by allocating to private markets, which can achieve risk-adjusted returns with low correlation to traditional assets and reduced volatility.
According to Schroders research, in the UK the number of companies listed on the London Stock Exchange has fallen 60% in the last three decades.
"The core appeal of LTAFs is the ability to reach highly attractive opportunities not available on public stock markets," said James Lowe, sales director at Schroders.
"In recent years there has been a snowballing effect, where more private capital available to fund growth has resulted in more fast-growing companies looking to private backers rather than to a stock market listing."
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Lowe noted that businesses operating in some of the most disruptive - and potentially high growth - sectors have remained in private ownership for longer, such as life sciences, AI, fintech and energy.
"The benefit of that growth phase for successful businesses backed in this way has been enjoyed by private investors, rather than shareholders via public markets," he said.
John Leiper, CIO of Titan Asset Management, said private markets offer the potential for strong investment returns, due to what is known as the illiquidity risk premium, which compensates investors for the risk of holding illiquid assets over prolonged periods.
A diversified portfolio such as an LTAF can offer a similar breadth of asset selection as the more familiar multi-asset portfolios which draw on quoted assets, said Lowe. However, he noted the "key" difference is that the potential universe for an LTAF is bigger.
Liquidity
Both retail and institutional investors are currently able to access long term, illiquid assets efficiently, and with the continuous provision of liquidity, through the UK closed-end market.
However, as Mark Northway, investment manager at Sparrows Capital, noted, the closed end market presents issues of scale. Secondary issues often trade at a discount, restricting the ability of existing funds to raise follow-on capital.
In the open-ended space, some fund managers have launched daily traded UCITS funds investing in property. However, on multiple occasions investors have found themselves locked in as funds are forced to suspend redemptions.
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The LTAF was devised to "bridge the gap" between daily trading and closed end propositions, he said, adding that in the eyes of the FCA and the Investment Association, it addresses the liquidity mismatch issue by limiting investors to monthly redemptions with a minimum 90-day notice.
"LTAFs potentially represent a halfway house, recognising the need to manage redemptions dynamically and to treat investors fairly," he said.
"This does not mean that the funds will not restrict or suspend redemptions, and it certainly does not guarantee a 90-day exit, but investors are at least forewarned."
Although Northway argued LTAFs do not yet present a "credible market", he said the combination of inflation, low expected market returns and lofty stock valuations is now driving investors and advisors towards alternatives.
"The search for uncorrelated returns may yet persuade investors to forgo the illusion of daily liquidity," he said.
Considerations
Due to their long-term nature, prevailing macroeconomic conditions are less relevant to private markets, compared to investing in public markets. However, this does not mean they are immune to market cycles.
"Investors who are new to this asset class should consider both ramping up and maintaining a diversified private market assets portfolio," said Phoebe Nguyen, head of UK institutional DC at BlackRock.
Titan's Leiper said providing private markets access to a wider range of investors is a philosophy the firm "strongly believes in", as long as the end client understands the risks involved and that the investment is intended for the long-term.
"Ultimately, the primary consideration will be to ensure that the underlying investments match the stated investment objectives, are sufficiently diversified and that the fund manager has the requisite expertise to oversee the strategy," he added.
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Nguyen argued effective portfolio construction is "paramount" in navigating the challenges and seizing the opportunities presented by private markets, especially when utilising LTAFs.
"Diversification, risk management, and a thorough understanding of the private asset landscape are fundamental in constructing resilient portfolios," she said.
Titan's Leiper said that as the "new kid on the investment block", LTAFs are likely to evolve over time, with the possibility of blending longer-term less liquid assets with more traditional listed securities within an LTAF structure.
"This approach would improve the overall liquidity profile of the fund, improve diversification and allow for a more tactical approach over the life cycle of the fund to optimise the risk-return outcome for clients over the market cycle," he said.