Investment in LTAFs set to be bolstered by ISA incorporation, but with a note of caution
Long-Term Asset Funds (LTAFs), a relatively new investment vehicle in the UK, offer retail investors access to private assets such as private equity, infrastructure, and commercial property. Although these funds promise diversification and higher returns, they come with significant risks that investors should be aware of.
Liquidity Risks
LTAFs invest in assets that are not easily sold without potentially impacting their value. Despite being designed to offer more liquidity than traditional private funds, the underlying assets themselves are illiquid. This creates a risk that investors may face delays or restrictions on redemption during periods of market stress or illiquidity, meaning investors might not access their capital promptly or at expected prices.
Fees
Fees in LTAFs tend to be higher compared to traditional public market funds. This is partly due to the complex management and operational efforts involved in private market assets. Retail investors may face higher management fees, performance fees, and other charges, which can affect net returns.
Valuation Risks
Valuing illiquid assets accurately and transparently is a challenge. Because such assets do not trade frequently, their valuations rely on models and appraisals, which may lag real market conditions and might be subject to greater uncertainty. This can result in discrepancies in reported Net Asset Values (NAVs) and actual realizable values, potentially misleading investors regarding fund performance or value.
Redemption Terms
LTAFs often have specific rules governing withdrawal or redemption, including notice periods and potential gate mechanisms to limit outflows. These terms are necessary given the underlying illiquidity but can be restrictive for retail investors who may not be accustomed to such investment constraints.
Proper investor education, transparent disclosure, and regulatory safeguards are key to managing these risks effectively. Morningstar, a leading investment research firm, has urged caution on liquidity, fees, and valuation regarding LTAFs. Confidence in the "experience and capabilities of the investment teams" is also important for LTAF investors.
The UK government has confirmed that LTAFs will be eligible for Stocks & Shares individual savings account (ISAs) from 2026, potentially opening up the market to more retail investors. The LTAF universe currently has just over 20 strategies available for sale in the UK, with the market expected to grow as the product structure beds in and distribution opens up.
Advisers have a pivotal role to play in guiding investors in LTAFs. Evangelia Gkeka, a senior analyst at Morningstar, stated that the change could serve as a catalyst for growth in LTAFs via the retail channel. Gkeka emphasizes the importance of education for advisers in guiding investors in LTAFs.
Transparent and regular asset marking is crucial for LTAFs. Setting clear and realistic risk/return expectations, aligned with the underlying strategies of each LTAF, is essential. LTAFs are designed to hold less liquid, longer-dated assets, and investors should not expect daily dealing or seamless exits.
In summary, while LTAFs offer attractive investment prospects, they also bring significant risks. Proper understanding, education, and careful consideration are necessary before investing in these funds. The change could drive progress in platform availability for LTAFs, making them more accessible to retail investors. As the LTAF market matures, it is expected to grow, offering more opportunities for diversification and higher returns.
[1] Morningstar (2022). Morningstar Cautions on Liquidity, Fees, and Valuation in Long-Term Asset Funds. [Online] Available at: https://uk.morningstar.com/uk/news/1134954/morningstar-cautions-on-liquidity-fees-and-valuation-in-long-term-asset-funds.aspx
[2] Financial Conduct Authority (2021). Long-Term Asset Funds Policy Statement. [Online] Available at: https://www.fca.org.uk/publications/policy/ps21-22
[3] Financial Conduct Authority (2021). Long-Term Asset Funds: Handbook Changes. [Online] Available at: https://www.fca.org.uk/publications/policy/hs21-027
[4] The Investment Association (2021). Long-Term Asset Funds: A Guide for Investors. [Online] Available at: https://www.theia.org/-/media/files/policy-and-resources/investment-guidance/long-term-asset-funds/long-term-asset-funds-a-guide-for-investors.pdf
Investors interested in LTAFs may encounter liquidity risks, as these funds invest in illiquid assets that could lead to delays or restrictions on redemption during periods of market stress or illiquidity. Additionally, the fees associated with LTAFs tend to be higher compared to traditional public market funds due to the complex management and operational efforts involved in private market assets.
