The Financial Conduct Authority has launched a new type of open-ended fund structure for illiquid assets such as property, infrastructure and private equity, but they will not initially be open to retail investors.
London’s financial watchdog long-term asset funds (LTAFs) are designed to attract more savings into illiquid assets after problems emerged with many open-ended property funds.
In recent years, many open-ended funds (also known as unit trusts), that invest in illiquid underlying assets have found it difficult to allow investors to redeem their investment on any given day without notice, and have often been forced to suspend withdrawals after a rush of redemptions – such as happened to several property funds after the Brexit vote and during the pandemic.
The open-ended fund structure means the managers need to give the cash back immediately to departing investors and, if there is not enough available in the coffers, they need sell an investment or two to generate the money.
Closed-ended funds such as investment trusts have no such problems, as investors can always sell their shares and the manager does not have to sell assets as a result.
Setting out the proposed rules for the LTAFs after a consultation period run in conjunction with the Bank of England, the FCA issued a policy statement today saying any funds operating under the new structure will be able to invest overseas as well as in the UK; will initially only be open to sophisticated investors, and professional investors and high net worth individuals; and will have a minimum potential lock-up period of 90 days, which could be extended for certain assets.
“We plan to consult next year on potentially changing the distribution restrictions on promoting LTAFs to a broader range of retail investors,” the FCA said in a statement.
The main buyers for LTAFs will be the largest pension funds, analysts said.
“Provided they have adequate liquidity management controls in place, this should present an opportunity to add a bit of diversification to these funds, and potentially harvest some additional long term returns,” said AJ Bell analyst Laith Khalaf.
“This will need to be weighed up against the charges for investing in LTAFs, particularly in light of the charge cap on pension default funds.”
Richard Stone, chief executive of the Association of Investment Companies (AIC), said the success of the policy, as the FCA defines it, hinges on whether products are launched with this structure and whether defined contribution (DC) pension schemes invest in them.
Stone said a number of his organisation’s concerns remain: “In particular, we fear the 90-day redemption notice periods will not prove sufficient, particularly in times of stressed markets. If too short, this could threaten the long-term resilience of the LTAF. It will be a challenge for managers to set adequate notice periods, especially if the structure also 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.”
He added that he is concerned that the FCA is proposing a review to consider wider retail distribution as early as 2022.
“This is too soon. There won’t have been time for LTAFs to be tested through difficult markets. Pension schemes and other institutions can evaluate the downsides of the LTAF alongside its proposed benefits, but retail investors do not typically have the same resources or ability to assess those risks. There is a risk of investor harm if the product is not allowed to prove itself through the economic cycle.
“We are still waiting for the results of the FCA’s consultation on open-ended property funds even though it closed nearly a year ago. This shows how difficult it can be to address flaws once a product has been established. We need to be certain this won’t leave LTAF investors with similar long-term problems.”
