“More unsupervised funds have been set up in recent years than supervised vehicles for alternative assets, but this can mask the consistent demand for regulated funds,” he said. For many investors, tax treatment and general regulatory comfort remain key factors in determining their choice. This is the case even if they are professionals who understand the risks they are taking, even for investments in asset classes such as real estate, infrastructure and start-up/growth companies.
For many investors, tax treatment and general regulatory comfort remain key factors in determining their choice.
New client options
It is just these kinds of investments which had been put off-limits for household, “retail” investors by regulators, even though the likes of state-backed infrastructure schemes, for example, are not inherently more risky than equities. To offer a response to the desires of smaller investors and to orientate their savings to long term investments contributing to the objective of the European Union was part of the reason for the EU to create the European Long-Term Investment Fund (ELTIF) in 2015. It is a regulated vehicle in which all types of investors, including retail investors, pledge to support a portfolio of projects for a long period of time, some time over ten years. However, it failed to ignite much interest as the regulations were deemed to be too restrictive.
However, the industry expects that ELTIF 2, which is due to come into force in early 2024, will give these products a greater chance of success. Fund managers will be able to target retail investors more clearly for the first time. For example, the type of assets eligible for investment will increase and there will be more flexible limits the investment approach, and minimum investment thresholds will be removed.
More liquidity, no gold-plating
The new ELTIF will also be more liquid. The mandatory percentage of long-term illiquid investments will be reduced from 70% to 55%, with liquid UCITS-eligible assets (mainly equities and bonds) making up the difference. This will facilitate the innovation of the funds being able to offer a degree of liquidity to retail investors. Currently these investments need to be fully locked-in for a certain period of time which can go up to several years, but ELTIF 2 will have the option of creating a liquidity window using a secondary trading mechanism. Mr Scodellaro suggests that these vehicles could be listed on stock exchanges, which would add a further dimension to ELTIF liquidity.
Another advantage is that the ELTIF is introduced via an EU regulation, rather than a directive which is liable to be changed at the national level. “The result is the only alternative investment fund that benefits from a marketing passport to retail investors across all member states, without the possibility for these member states to add further restrictions,” said Mr Scodellaro.
Luxembourg has the experience
Luxembourg is well placed to benefit from any such market trend. “We have the perfect mix of experience here, with decades experience serving UCITS for retail clients, with a leadership position in the cross-border European alternative space,” he added. He mentioned the range of service providers in this country, as well as the technological expertise. There are also flexible regulatory tools, such as the versatility and possibility to target retail investors enshrined in Part II of the 2010 law on investment funds which is ideal for ELTIF-compatible strategies.
“A lot of the Part II funds established recently have been designed to host ELTIFs,” he said. “Traditionally alternative funds have a handful of investors, rather than the thousands which could have a share in ELTIFs. Luxembourg has the experience of serving both these aspects.” This is reflected in the European statistics, with the vast majority of ELTIFs created in the recent years being Luxembourg based, of which two-thirds use the Part II regime.
New investing and marketing challenges
However, Mr Scodellaro pointed out that there are fresh challenges with this type of fund. In a traditional capital call mechanism by an alternative fund, the asset manager will raise the cash and then take a period of time to identify suitable assets and call the cash committed by the investors, a process that can take years. This delay might be less acceptable to a retail investor which will pay all its investments in the ELTIF upfront, so asset managers will need to move quickly.
Independent asset managers will need to find the appropriate distribution network with the right characteristics for your type of fund
“Then there is the challenge of reaching the retail investor,” he noted. Some asset managers are owned by retail banks, but for others there will be considerable marketing work to be done. “Independent asset managers will need to find the appropriate distribution network with the right characteristics for your type of fund,” he said. Some ELTIFs will be focused on very wealthy investors, while others targeting the so called “mass affluent” sector, which requires a specific distribution network with whom the asset managers are not always familiar with.