What role can long-term asset funds play in portfolios?

The forced suspension of redemptions from physical property funds on multiple occasions over the past decade and the collapse of Neil Woodford’s investment firm, partly as a consequence of liquidity problems, highlighted the issue of holding illiquid, non-stock-market-traded assets in funds that offer clients the chance to redeem their investment at one day’s notice. 

LTAFs will instead require clients to give a minimum three months notice if they wish to sell their holding; individual fund providers can require a longer notice period if they wish, but not one which is shorter. 

FTAdviser understands there are between six and eight applications currently being assessed by the FCA from providers wishing to launch such funds. 

In terms of where the demand will come from, Jock Glover, strategic partnerships director at consulting firm Square Mile, says: “Many investment trusts invest in the same sort of assets as LTAFs will, and those offer daily pricing. But the big institutional investors and wealth managers are not able to buy investment trusts for liquidity or risk management reasons.

"Most investment trusts are bought now by retail investors, so they may not be that interested in LTAFs. At the other end of the scale, the very big institutional investors can access private equity funds, and so they may not need LTAFs.

"But in the middle of those are the wealth managers who are too small for private equity, but too big for investment trusts, and the same with some of the pension schemes and ultra high net worth individuals. Those sorts of investors can have a long time horizon and don’t need daily dealing, so the three month notice period is no problem.”

Based on his contacts with some firms that are contemplating bringing LTAFs to market, he says funds investing in private debt and equity, infrastructure and also now renewable energy assets. 

Jason Hollands, a managing director at wealth management firm Evelyn Partners, says that while investment trusts do offer the chance for investors to redeem their holding on a daily basis, in times of market stress one is likely to have to accept a steep discount relative to the underlying net asset value of the assets. 

With this in mind he regards the creation of LTAFs as a "broadly welcome" development and alternative to investment trusts.

Pricing power 

Under FCA regulations, LTAFs must have at least 50 per cent of their assets deployed into unquoted assets, and must produce value for money assessments in the same way regular funds currently do.

But there is also much to be decided, with the regulator still working on the question of how frequently a fund has to publish its net asset value, that is, the value of the assets in a fund.

These types of investment need much more management and active involvement.Russ Taplin, Altus

Daily dealing funds and investment trusts produce NAVs on a daily basis, enabling investors to see the value of their investment. 

Glover says providers are keen to launch LTAFs instead of investment trusts right now because with the latter the funds must be raised within a fixed time period under stock exchange rules, so LTAFs are potentially easier to bring to market. 

He acknowledges that the other reason asset management firms are keen to launch LTAFs is the potential to earn a higher profit margin.

He says the fee charged on daily dealing funds is now below 0.65 per cent, squeezing the profit margins, but LTAFs can probably charge north of that.

The scale of the revenue opportunity can also be seen by comparing the valuations at which private equity fund providers trade, relative to conventional asset managers. 

There will be a greater reliance on making sure your adviser is in a place to understand the risks and returns of these types of funds.Russ Taplin, Altus

An example of this is Partners Group, a private equity fund provider with assets under management of around £130bn, and that has a market capitalisation of about £19bn; and Shroders, the first firm to have approval for an LTAF fund, which declared AUM of around £737.5bn in their most recent set of accounts, and which trades at a market cap of around £7.7bn. 

Additional to the higher fee earning potential, because LTAF funds do not offer daily redemptions and will not have to publish valuations on a daily basis, it could be that the share prices of firms who manage a significant portion of their assets via LTAFs are less volatile in the face of wider equity or bond market movements than those of more conventional firms.

Opportunity knocking?

But if those are the regulatory and commercial reasons to launch LTAFs, do advisers and wealth managers actually see a role for them in the portfolios they manage for clients? 

Russ Taplin, a consultant at Altus, says: “These types of investment need much more management and active involvement, in everything from sourcing the individual investments, to valuing and managing them – so it will be interesting to see how the respective returns compare to what we would expect to be higher than typical fees.

"From an investor’s perspective, there will be a greater reliance on making sure your adviser is in a place to understand the risks and returns of these types of funds, and understand the more active participant nature of them too.

Usually these strategies are marketed as offering two benefits to clients... But there are two main counters to these benefits.Rory Maguire, Fundhouse

"The key thing will be understanding your retirement journey, and how a LTAF interacts with your desire for income, growth or stability as part of your retirement funds."

Rory Maguire, UK managing director at Fundhouse, says: “Usually these strategies are marketed as offering two benefits to clients. First is enhanced returns through the illiquidity premium.

"Put another way, there are more buyers and sellers in the listed space, so the theory goes that unlisted investments can be more keenly priced because there are a handful of buyers and sellers. The second is a lower volatility return. On the second, this is not a genuine gain, but rather an administrative gain. There are two main counters to these benefits.

"First is cost; private equity funds tend to have expensive fees and fees that can be linked to formulas like IRR, not the return that clients necessarily get. The second is liquidity, the same issue facing property funds, for example. The investments cannot be easily sold to meet redemptions, so clients tend to be locked in.”

He adds that even if an adviser is keen on the investment case for LTAFs, the second challenge is to understand which of the funds are likely to perform well. 

It appears a good idea in principle but will rely on there being a balanced number of buyers and sellers to create liquidity.Simon King, Vermeer Partners

Maguire says: “As fund researchers, we often look at the listed names within a fund to see whether the fund manager is doing what we expect. On listed names, we can access long form annual reports, interim reports, presentations, sustainability reports and sell-side reports. And we look at this data often.

"But private holdings tend to have lesser reporting and almost no sell-side coverage, so they make it difficult to assess the fund manager’s process. And, at times, the investment manager may be an insider (if they own a large equity stake and/or become a board member) and actually cannot say much at all.”

Taplin says the challenge of finding the right fund to invest in is also likely to be hindered by the fact that lots of institutional and government money is entering the private assets space, and the number of assets in which to invest is finite, so prices may rise quickly. 

Simon King, chief investment officer at Vermeer Partners, says: “It appears a good idea in principle but will rely on there being a balanced number of buyers and sellers to create liquidity. History tells you this will not always be the case.

"It will also be dependent on not letting any foxes into the chicken house, that is, rogue managers pillaging on fees. The FCA will have to earn its corn.”

David Thorpe is investment editor at FTAdviser