Composed of assets that are not publicly traded such as real estate and infrastructure, private funds are normally reserved for professional investors. However, in recent years there have been efforts to open these funds to retail-type investors, with distribution carried out by financial intermediaries such as private banks and wealth managers. Regulatory regimes such as ELTIF 2.0 aim to ease the process, but some challenges remain. One of the challenges of such democratisation fund projects, also sometimes called retailisation, is that non-professional investors generally require a certain degree of liquidity, yet most private funds are composed of illiquid assets.
We prefer to use the term ‘democratisation’ to ‘retailisation’ because it better aligns with the type of investors targeted by these private funds as opposed to the purely legal and technical definition of professional vs retail clients .
Single and multi-asset strategies
The U.S. REIT model first crossed the Atlantic decades ago and inspired fund managers in Europe to create similar funds with a single-strategy platform, mostly focused on real estate. In recent times, real estate has become a more difficult asset class in terms of valuations and fundraising. Interest has broadened into other asset classes such as private equity and private credit, the latter of which is now very popular due to rising interest rates. Private funds targeting non-professional investors are therefore increasingly becoming multi-strategy, made up of different sub-funds or compartments, each with a different strategy: real estate, private equity, private credit, and infrastructure, all working alongside each other.
Some funds built on a multi-strategy platform may even apply for the ELTIF label, which is also something we see happening within a single umbrella platform and is an interesting evolution .
Luxembourg: an obvious domicile choice
The true democratisation project is very broad in scope and aims to build platforms that target not only the 27 EU member states, but also the UK, Switzerland, and beyond. Luxembourg is strongly positioned as a domicile due to a plethora of factors. These include the country’s history of private banking and wealth management; its expertise in UCITS, which are not only distributed to non-professionals across Europe but also in Asia; the familiarity of Luxembourg to global managers; Luxembourg’s famous toolbox and structural flexibility; and its expertise in Part II UCIs.
ELTIF 2.0: a much-needed revolution or a welcomed evolution?
The ELTIF regime and especially its successor ELTIF 2.0 have been lauded as a leap toward retailisation, but several democratisation projects were launched prior to ELTIF 2.0 under the Part II UCI regime, which has allowed retail investors to commit to private funds. The market did not necessarily need the ELTIF label to open private funds to retail investors, and within the 1.0 framework, it does not even appear to be a natural fit for democratisation fund projects. For instance, an ELTIF 1.0 is closed-ended, yet retail investors look for more open-ended funds that offer redemption windows.
For the moment, some uncertainty surrounding ELTIF 2.0 remains. The rules around liquidity are quite vague, and the market is eagerly waiting how ESMA technical standards play out in practice with regard to minimum holding periods, redemption frequency, etc. Despite the uncertainty, the market remains optimistic about ELTIFs, and many players do expect to see regular liquidity windows.
We believe that ELTIF 2.0, despite its merits, is not a strict requirement to make democratisation fund projects a success, but it is definitively worth considering in relation to any fund targeting retail investors .
Of course, ELTIFs come with a passport for non-professional investors, which is a helpful addition to a fund setup. Fund managers might pursue an ELTIF as a sort of label on top of a Part II UCI, which is a structure often seen for these sorts of projects.
The need for liquidity
To address the great liquidity question, fund managers have several techniques at their disposal. First, they can build a liquidity pool into a fund, meaning that 10 to 20 percent of the investments are more liquid instruments. Also, managers can match subscriptions with redemptions, which limits liquidity demands. Funds sometimes establish a borrowing provision that can be called on in case of need. And of course, many private funds simply apply restrictions on redemptions, such as soft-lock provisions, a sort of penalty on early redemptions. These, combined with other liquidity management tools, may all be used to balance the liquidity expectations of investors with the nature of the underlying illiquid investments, thus ensuring the right safeguards for the investor and the fund manager alike.