How are LTAFs evolving?

Although the products will likely only be coming onto the radars of advisers now, the inception of LTAFs goes back to 2021, when a regulatory framework was created for these products following consultations.

That framework was designed around defined contribution pension portfolios, rather than for advised clients.

LTAFs are able to own assets that cannot be sold quickly to meet redemption requests from clients, with four areas of focus: private equity, infrastructure, property and private credit. 

Unlike other open-ended funds, there is no daily liquidity with LTAFs; clients are required to provide a minimum notice period of three months, and then may have to wait a month to actually receive the cash. 

All of those asset classes can be accessed in a way that offers daily liquidity, via investment trusts, but most DC pension plans, and increasingly many wealth managers, are too large to be able to invest in those vehicles. 

The issue of liquidity within open-ended funds has been impactful for advisers for many years as a result of physical property funds being forced to suspend withdrawals during periods of political and market instability, and the suspension of the Woodford Equity Income fund. 

Time sensitive

James Lowe, sales director of private assets and investment trusts at Schroders, one of the first firms to launch an LTAF, says: “The regulator's view was that pension funds can have the long-term time horizon and so can tolerate the illiquidity of the asset class. The fund structure itself is not new; open-ended fund evergreen structures have existed in Luxembourg for many years.” 

When applying to the regulator for permission to launch an LTAF, Lowe says: “You have to demonstrate that the liquidity of the underlying asset class is aligned with the withdrawal terms of the fund, you can’t just use a cash buffer.” 

Many of the open-ended property funds that ran into trouble had tried to mitigate the illiquidity of physical property as an asset class by retaining a substantial portion of the funds in cash, typically around 20 per cent, and to use this buffer to meet client withdrawal requests.

That led to clients having 20 per cent of the capital they wanted to invest in property in cash, which they pay a fee on and impacts performance, however it was not sufficient to prevent the funds suspending withdrawals.  

These are not going to be suitable for most retail investors.Jason Hollands, Evelyn Partners

One of the ways the FCA has sought to ensure that LTAFs will retain sufficient liquidity if they are offered to advised clients is to make it a pre-condition of their launch that they cap the total amount that can be withdrawn from a fund each month. 

In the case of Schroders' private equity evergreen structures, which are not LTAFs but may be an example of what can be done within the open-ended structure, Lowe says they set a limit of 5 per cent for withdrawls, based on the fact that the fund generates capital gains, without selling assets, of 5 per cent a year” to instead read: “Lowe says they set a limit of 5 per cent for withdrawals, based on the fact that the fund asset base, in normal conditions, is expected to generate cash distributions or realise capital in line with this level”.

WTW are the latest firm to announce the creation of an LTAF, initially regulated for DC pensions but with the intention to launch in the advised space in time. 

Ben Leach, head of private market solutions at WTW, says his view is that private equity “is the asset class with the longest-term time horizon”, and so suits funds that do not offer daily dealing.

He says an exposure to private equity can significantly enhance the returns of clients in DC pensions, and says the time horizon works because the average age of a client with a DC pension pot is currently 43. 

WTW’s LTAF invests directly in the shares of companies, rather than in private equity funds; usually the LTAF is investing in the same deals as the private equity funds that other parts of WTW are invested in.

Leach acknowledges that higher interest rates have created challenges for private equity funds, at the same time as many such funds have an excess of capital to deploy, with the former creating the potential to devalue existing holdings, and also to keep valuations high, and make it difficult to find good investment ideas. 

He says WTW’s approach is to own slightly smaller companies that might be the case for other private equity funds, as he believes valuations are better there.

Leach adds that he regards many of the issues around debt as being short term in nature, but adds that “some managers of private equity funds do use [debt] and it has to be factored into the business case when choosing a fund or choosing to invest alongside a fund”. 

He says the typical level of investment from the LTAF into any one company will be somewhere around £30mn, and they would not invest more than £50mn into any one company. 

The WTW fund will retain a portion of the capital in liquid assets in order to comply with the FCA requirement that withdrawals be capped at a level that does not require assets to be sold to meet redemptions. 

Aviva Investors has so far brought two LTAFs to market, which are focused on property and the climate transition theme. 

Mark Meiklejon, head of real asset investment specialists at the firm, says the FCA rules around LTAFs require the bulk of the capital to be invested directly in the asset, for example into a physical property rather than the shares of a company owning physical property, and he says that owning and managing a physical property is a good way to approach this.

Supply and demand 

Jason Hollands, managing director of corporate affairs at Evelyn Partners, says: “It is early days for LTAFs, and we are closely watching developments in this space.

"In my view the creation of fund structures designed to accommodate illiquid asset classes with longer lock up periods is a broadly welcome development, but these are not going to be suitable for most retail investors. It is right that these should be aimed at investors who are taking professional advice, given the risks and suitability considerations.”

As mentioned above, clients can get exposure to the same asset classes as are present in LTAFs by owning investment trusts, but Hollands says there are limits to the effectiveness of this as well. 

He says: “Currently we use investment companies to access underlying asset classes that are illiquid in nature and suitable for opened funds with daily dealing. This includes areas like operational infrastructure, physical property and private companies.

"A closed end structure is well suited for this, and listed investment company shares can be sold on the secondary market if an investor needs to sell. But of course, there will be periods when investment company discounts widen, and share price performance can become divergent from underlying portfolio returns.”

Discounts widening is usually caused by negativity towards equities as an asset class, because equities are listed on a stock exchange.

The problem for a client here is that they may wish to own private equity, debt, property or infrastructure as a diversifier away from equities, but owning a fund that is listed on the stock exchange may mean one is taking equity risk anyway.

Oli Creasey, property analyst at Quilter Cheviot, says he is watching property LTAFs with interest, but says his enthusiasm is “tempered” by both the lack of choice right now but also the lack of track record of such funds in times when the property market performs poorly. 

David Thorpe is investment editor of FT Adviser