A new type of fund – here’s everything you need to know

Back in 2021, the Financial Conduct Authority brought into being a new form of open-ended fund, snappily known as Long-Term Asset Funds (LTAFs).

There were several aspects to LTAFs’ introduction. In part, they were a response by the investment industry to the government’s drive for an “Investment Big Bang” to boost Britain’s long-term growth.

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At the same time, the aim was to provide defined contribution pension funds with a simple and efficient way of investing in illiquid assets including real estate and infrastructure, venture capital, private equity and private debt.

These alternative private market asset classes have been shown to provide better long-term returns than listed investments and to improve portfolio diversification over the long term.

However, because they are illiquid they are also relatively high-risk investments, as the Pensions and Lifetime Savings Association (PLSA) explained in its 2021 publication, LTAF Made Simple: “The holding period of such private markets investments is typically several years (four to seven years on average), which is in stark contrast to public markets investments such as listed equities or bonds, where these can typically be traded daily.”

In addition, this new fund structure also potentially addresses shortcomings with illiquid assets with open-ended funds. As we’ve seen time and time again, during periods of stress property funds have put suspensions in place, due to the illiquid nature of that asset class.

Under the LTAF structure, investors won’t be able to sell on a daily basis. Instead, LTAFs will have a redemption period of at least 90 days. Therefore, investors in LTAFs have to be prepared to sit tight.

Long-term investing is, of course, exactly what pension funds set out to do – indeed, defined benefit pension schemes (final salary) have been taking advantage of private market assets for decades – but their DC pension counterparts have historically had very limited access, says the PLSA.

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LTAFs were also envisaged as a broader vehicle for private investors. As Dominic Byrne, head of defined contribution strategy for Europe, the Middle East and Africa at BlackRock, explains that LTAFs were introduced by the FCA as a move “to cater for two key policy themes: encouraging greater use of alternatives in defined contribution (DC) pension portfolios, and democratising access to private markets for non-professional investors”.

That “democratisation” finally took place at the end of June, with the extension of LTAFs to allow mass market retail investors, SIPP investors and self-select DC pension schemes to use them.

Since their initial introduction, says Byrne, some asset managers have launched LTAFs for DC schemes: “These funds have seen strong buy-in from the industry and government, which has helped to maintain the momentum.”

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But in light of the recent expansion of their reach, he adds: “There is also increasing interest from managers and clients for LTAFs that aim to unlock the UK wealth market. It remains to be seen how far this market and client demand develops, but we are closely monitoring this space.”

Early days then, but potentially an interesting development for private investors with a long-term investment horizon. So what, specifically, do LTAFs bring to the table for these investors?

The case for LTAFs

On the plus side, as mentioned, they provide access to privately owned assets, a whole tranche of the investment arena that is by definition more difficult for ordinary investors to access but has been a rewarding area to be in over the long term.

Figures from the PLSA’s 2021 guide show, for example, that over 20 years to June 2019 the US S&P 500 index returned a net annual average of 6%, compared with 11.6% for private equity (US buyout funds). Over 30 years, the respective annualised figures were 8.1% and 13.1%.

That outperformance comes from several sources. Private market investors tend to take controlling equity stakes and a place on the board, so they can make more impact than a listed equity manager.

Moreover, the longer timescale means managers can have a stake in the bigger picture and long-term strategic growth plans for the business, rather than needing to focus on short-term initiatives driving imminent earnings and profits.

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Finally, because LTAFs are inherently illiquid, they are not under the same pressure as listed equity managers to sell and crystallise losses when markets are volatile.

With broad access to these private market asset classes, and used alongside more liquid listed assets, LTAFs could help private investors to boost their portfolio performance.

Rowan Stone, sustainability portfolio manager at wealth manager atomos, sees many benefits from clients being able to access a larger universe of high-quality opportunities. These include “unique exposures, diversification, and providing capital for companies and projects that public markets and governments could not fund”.

Stone says they will also be valuable in building more sustainably focused portfolios. “This broadened access to private markets will help them influence change more effectively and support collectively meeting sustainability objectives, such as net zero,” she explains.

The case against LTAFs

However, there are a number of question marks around the new funds. Tiffany Tsang, head of investment at the PLSA, believes the industry will need to put in some work to encourage, support and protect investors.

Tsang says: “We don’t yet know what the appetite is for these products on the retail market. As these are inherently higher-risk products, their success in the retail market will depend in part on how well firms can provide the necessary guidance and explain the benefits and the risks involved, to ensure consumer protection.

“With the right guidance scaffolding in place, however, they may help to encourage greater investment into less-liquid assets, which could in turn help to promote wider UK economic growth.”

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Stone agrees that proper education is essential. “Private markets will be a new area for most private clients, so it is vital they fully understand the risks involved and have the ability to weather some volatility,” he warns.

There may also be practical problems. Tsang makes the point that the FCA itself has observed that investment platforms are set up to accommodate funds that deal daily, and therefore may not be able to work with LTAFs, which deal only occasionally. “This will need to be resolved as well for the long-term success of LTAFs,” she adds.

Other challenges highlighted by Stone include questions of how to keep costs down, achieve sufficient liquidity within the funds, and create structurally appropriate products for a broad retail market.

The FCA is also in consultation as to whether to include LTAFs within the Financial Services Compensation Scheme (which provides up to £85,000 per person per authorised firm if you lose money if the firm fails, or because of poor advice or negligent or fraudulent management).

How are they different to investment trusts?

One key question for many ii investors will no doubt be around the difference between LTAFs and investment trusts, which already do provide relatively easy access to a range of relatively illiquid alternative assets, including private market assets.

The big difference is that investment trusts, unlike LTAFs, are listed companies, and therefore can be traded on the stock market on a daily basis.

“Investment trusts, like LTAFs, have a high degree of flexibility in constructing their portfolios, including a mix of both public and private assets,” explains Byrne.

She adds: “As listed equites, investment trusts are more liquid, but their pricing can be more volatile than the underlying assets, reflecting secondary market supply and demand in addition to movements in the net asset value (NAV).”

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For Dzmitry Lipski, head of funds research at interactive investor, the two vehicles could potentially complement each other in an investment portfolio.

“Traditionally, our customers have tended to opt for investment trusts over funds when it comes to illiquid assets, but that doesn’t mean that there is no room for LTAFs on a selective basis,” he says. “No structure is perfect. The price you pay for daily dealing in investment trusts is the discount, and any investment trust or fund is only ever as good as the people running it.”

Nonetheless, the adoption of LTAFs by retail investment platforms such as interactive investor may be some way off, given the potential problems around dealing and the need to ensure investors understand exactly what they are getting into. But wealth managers and financial advisers may be in a position to make use of them more quickly, once they become available.

“Providing there were LTAFs available that provided suitable strategies, and these made it through our rigorous investment process, we would certainly look to utilise these vehicles within our portfolio where appropriate,” says Stone.

The obvious group would be high net worth discretionary clients, she says, as they “generally have more capacity to take risk and tend to be more sophisticated investors”. She adds that LTAFs might also be incorporated within atomos’ multi-asset funds, although liquidity concerns might prove a stumbling block.