Written by Mark Northway, Investment Director at Sparrows Capital
The FCA hopes that it has found its Maria in the long-term asset fund (LTAF), although many investors think more auditions are needed.
The regulator seems confident in its new star’s ability to address issues surrounding investment in illiquid assets.
But, in contrast with the Andrew Lloyd Webber show ‘How to solve a problem like Maria’, the audience isn’t entirely enraptured.
There is undoubtedly logic in the LTAF approach, but major questions remain, including whether a new fund structure is really needed, and whether a 90-day (plus) notice period for redemptions will truly solve the illiquidity issue.
Existing avenues
The desire to make illiquid investments available to a wider pool of investors in the safest way possible is laudable.
The broad-based consensus is that the likes of DC pensions schemes are missing out on attractive potential returns by not being able to safely access private equity, private debt, real estate, and infrastructure.
Yet, investment trusts already provide perfectly good structures to do this.
Investment trusts are permanent capital vehicles, meaning that a corporate entity owns the assets, but then issues listed shares to provide investors with access to those assets.
Investors can trade their shares whenever they like, without the investment manager being forced to sell holdings to fund investor redemptions. Investment trusts may trade at a premium or discount to net asset value, so the liquidity transformation process is not without cost.
Conversely, open-ended funds – including LTAFs – require cash to be held and / or assets to be sold to meet net redemptions. This is the case even where the structure has a 90-day notice period.
Unclear logic
The LTAF structure promises liquidity, albeit with a delay, buying the manager time to liquidate a representative selection of assets. This reduces the temptation for managers to sell the more liquid assets to meet redemptions, thereby disadvantaging continuing investors.
But the structure doesn’t get around the issue of what happens if everyone wants to use the exit door at the same time.
In such a scenario, it isn’t certain that a fund manager would be able to sell the required holdings within 90 days, or what price they would receive for them.
As Richard Stone, chief executive of the Association of Investment Companies, said in research it carried out on the impact of the Woodford collapse on clients, “to prevent investors getting burned again, the LTAF must be based on robust regulatory standards”.
“Broad distribution of the LTAF before it is tested through an economic cycle risks exposing investors to fire sales of assets, suspensions and fund failures, which can arise from liquidity mismatches, as we saw with Woodford Equity Income,” Stone added.
Alternative options
One potential ‘Maria’ is an adjustment of UCITS rules to take specific account of the liquidity of a fund.
If the regulator is on to something with a notice period, perhaps it’s the bluntness of it in the LTAF rules that is the real issue.
Why 90 days? Is that an illiquidity panacea? Most of us will have been involved in domestic property transactions tat have taken considerably longer.
Perhaps it would have been more beneficial to create a tiered system whereby the more illiquid positions a fund holds or plans to hold, the greater notice period is required for redemptions.
This could have avoided the need for a potentially superfluous fund structure and would focus investors’ minds on liquidity risk.
Influential ideas
Interestingly, the whole idea of an LTAF seems to have been suggested by the Investment Association, whose fund management members overwhelmingly run open-ended products.
The IA said in its October 2022 letter to the regulator that it “supported the proposals” after its UK Funds Regime Working Group “originally proposed the LTAF in 2019”.
Would the LTAF ‘Maria’ have been chosen by the FCA had it not had such a vocal proponent? Is this the best option, or just the option that was tabled by the industry lobby?
It seems the regulatory hills will be alive with the sound of intense debate for some time to come.
