The success of UCITS funds, which have helped to make Luxembourg one of the world’s most important fund centres, is well known. These funds, which have existed for over 30 years, are intended for the general public. They benefit from broad passporting capacities but are highly regulated and do not provide access to all asset classes and investment strategies.

In the meantime, the EU passport was also introduced for alternative investment funds in 2013 but is limited to professional investors.

There were consequently two distinct frameworks for retail and professional investors. “Some years ago, we had already seen UCITS being used by hedge fund managers to replicate their strategies under a UCITS format,” explains Florence Stainier, Partner at Arendt. “More recently, with the lower level of interest rates combined with the uncertainty of expected returns of traditional asset classes as compared to the yields of alternative ones, we have witnessed an acceleration of two converging trends: the will of traditional asset managers to leverage their investor network to offer exposure to new asset classes and the appetite of alternative asset managers to expand their scope of targeted investors.”

A regulatory helping hand             

In an industry as controlled as asset management, political willingness and regulatory developments have also played a clear role in accelerating this trend.

The creation of ELTIF represents a further step towards retailisation. “ELTIF is a European vehicle that gives certain retail investors the benefit of passporting. That said, it should be noted that certain conditions have to be met in order to access it,” says Fiona de Watazzi, Counsel at Arendt.

In addition to this, renewed interest was given to the Part II fund, which provides access to alternative asset classes. Part II has been part of the Luxembourg toolbox for many years, but had lost traction. “Given the environment as described above, this vehicle, which has been somewhat dormant for years, is now on everyone’s lips,” continues Fiona de Watazzi. “It’s open to all types of retail investors with no restrictions. It can also be used to invest in all kinds of assets: it’s even possible to create an ELTIF sub-fund within a Part II fund to achieve an effective combination. However, except in the case of an ELTIF sub-fund, it does not have the passport to be sold easily to non-professional investors. There is a clear dichotomy here.”

Distribution challenges and opportunities

“Although Part II funds are available to retail investors, professional investors only benefit from the alternative investment fund passport. Hence, if you want to sell a Part II fund abroad to non-professional investors, you need to check, on a case-by-case basis, whether this is possible in the relevant jurisdiction. Things are very different with the ELTIF Fund, which has the advantage, under its passport, of automatic recognition between countries. This saves us the difficulty of a case-by-case analysis. However, ELTIF has the disadvantage of being more restrictive in terms of asset classes and hence possible investment strategies,” explains Florence Stainier.

The other point of attention with alternative assets being offered to retail investors is their illiquid nature, which may not be suitable for all types of retail investors. “Many investors don’t want to tie up their funds for ten years,” says Fiona de Watazzi. “It is therefore necessary to manage liquidity in this type of vehicle, including by implementing liquidity pockets or liquidity management tools, which allow redemption requests to be authorised under limited conditions.”

In this context, the high level of expertise in the Luxembourg market is proving very useful, whether for developing ELTIF or Part II funds that meet managers’ and investors’ needs. “The Luxembourg ecosystem and expertise which helped to make UCITS funds a success is just as useful for these types of funds,” says Florence Stainier.

While it is difficult to prejudge the long-term success of the vehicles mentioned here, there is no denying that they are symptomatic of a clear trend towards the retailisation of alternative asset classes. Other factors — such as the tokenisation of funds — also indicate that the march towards democratising access to alternative assets is unlikely to slow down soon.

“We expect this trend to be reinforced by the anticipated review into the definition of a professional investor. It might lead to less stringent classifications of what constitutes a professional investor and could open passport access to extended categories of investors, notably those with a high net worth,” concludes Florence Stainier.

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