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The investment landscape is evolving with the introduction of new fund structures designed to channel more capital into long-term, illiquid assets. In the UK, the Long-Term Asset Fund (LTAF) and in the EU, the European Long-Term Investment Fund (ELTIF) are paving the way for broader investor access to private markets and infrastructure investments. These innovative structures aim to democratize access to alternative investments while supporting economic growth and development. The UK's Long-Term Asset Fund (LTAF)Introduced in 2021 by the UK's Financial Conduct Authority (FCA), the LTAF is a new category of open-ended authorised fund designed to invest efficiently in long-term, illiquid assets.&nbsp; Key features of LTAFs include:- Structure: Can be structured as an authorised contractual scheme (ACS), authorised unit trust (AUT), or open-ended investment company (OEIC)- Eligible investors: Professional investors, DC pension schemes, sophisticated investors, and high net worth individuals- Investment focus: At least 50% of assets must be invested in long-term illiquid assets- Investment flexibility: Can make direct investments and invest in other funds, including unregulated collective investment schemes- Borrowing limit: Up to 30% of net assets- Redemptions: No more frequent than monthly with a minimum 90-day notice period- Valuation: Requires appointment of an external valuer Recent developments:- Schroders Capital received approval for the UK's first venture capital-focused LTAF- LTAFs can be held within Innovative Finance ISAs from April 2024- Retail access has been broadened, including to self-select DC pension schemes and SIPPs The EU's European Long-Term Investment Fund (ELTIF)Originally introduced in 2015, the ELTIF framework was recently updated with "ELTIF 2.0" coming into effect in January 2024. This revision aims to make ELTIFs more attractive to both investors and fund managers. Key features of ELTIF 2.0 include:- Structure: Closed-ended fund regulated under EU legislation- Eligible investors: Both retail and professional investors across the EU- Investment focus: Long-term investments in the EU economy, with broadened scope under ELTIF 2.0- Investment flexibility: Can make direct investments and invest in other EU Alternative Investment Funds- Borrowing limit: Up to 50% of NAV for retail-marketed ELTIFs, 100% for professional-only ELTIFs- Redemptions: New provisions for optional liquidity windows and secondary market trading- Valuation: Aligned with AIFMD requirements Recent developments:- Expanded eligible assets including green bonds, fintechs, and global investments- Removal of minimum investment amounts for retail investors- Introduction of master-feeder and fund-of-funds structures Investment StrategiesBoth LTAFs and ELTIFs offer flexibility in their investment approaches: 1. Direct Investments: These funds can invest directly in long-term, illiquid assets such as private equity, venture capital, real estate, and infrastructure projects. 2. Fund of Funds: They can also invest in other funds, allowing for diversified exposure to multiple strategies or sectors. This dual approach allows fund managers to create diverse portfolios tailored to specific investment objectives while providing investors with access to a broad range of long-term investment opportunities. Shared Objectives and BenefitsBoth LTAFs and ELTIFs aim to:1. Provide investors with access to potentially higher returns from illiquid assets2. Offer portfolio diversification opportunities3. Channel capital into long-term projects and the real economy4. Align with long-term investment horizons, particularly for pension funds5. Provide a regulated structure with investor protections EconomicsWhile specific fee structures may vary, both LTAFs and ELTIFs typically involve:- Management fees: Usually around 1-2% of assets under management- Performance fees: May be included, subject to regulatory guidelines and disclosure requirements- Carried interest: Common in private equity-style investments, typically around 20% of profits above a hurdle rate Investors should carefully consider the total cost of ownership, including all fees and expenses, in the context of potential long-term returns and diversification benefits. Looking AheadThe success of LTAFs and ELTIFs will depend on how well they balance investor protection with flexibility for fund managers. As these structures evolve, they have the potential to play a significant role in democratizing access to private markets and supporting long-term economic development. For investors, these funds offer new opportunities to diversify portfolios and potentially enhance long-term returns. However, it's crucial to understand the risks associated with illiquid investments and the specific terms of each fund. For fund managers, LTAFs and ELTIFs present opportunities to tap into new sources of capital and offer innovative products to a broader investor base. The ability to employ both direct investment and fund of funds strategies provides additional flexibility in portfolio construction and risk management. As the investment landscape continues to evolve, LTAFs and ELTIFs represent important innovations in connecting diverse pools of capital with long-term investment opportunities. Their development and adoption will be closely watched by investors, fund managers, and policymakers alike, potentially reshaping how capital is allocated to long-term, illiquid assets across the UK and EU.

LTAFs and ELTIFs: Unlocking Long-Term Investments in the UK and EU

Pension funds, the silent guardians of people's retirements, manage a staggering $76 trillion globally, with a whopping $4.6 trillion entrusted to them in the UK alone. How these vast sums are invested impacts the comfort and security of retirees. In this context, we drive into two key questions that shape pension investment strategies:<ol><li>Should pension funds prioritize local economic growth, or focus solely on maximizing returns?</li><li>And how do alternative investments like private equity stack up against traditional investment options?</li></ol> Balancing Returns and Local ImpactLet's start with the basics. The fiduciary duty of a pension fund is to generate the best possible returns to ensure retirees can maintain a comfortable standard of living after they stop working. Governments may advocate for investing in local economies, citing tax breaks offered to pension funds. However, when it comes to investment decisions, maximizing returns for pensioners must be the top priority. Without delving into the politics of it, local investments are attractive if they deliver strong growth potential. There are arguments put-forward by entrepreneurs that pension funds must invest locally, <a href="https://www.theguardian.com/business/article/2024/jul/12/british-chipmaker-graphcore-bought-by-japans-softbank" rel="noopener noreferrer" target="_blank">most recently by the founder of Graphcore</a>. This distills down to: Should the responsibility of driving economic growth fall on the shoulders of pensioners through their investments, or should retirees simply benefit from the economic growth generated by the broader economy? Exploring Alternatives UK FTSE 100 has historically delivered around 7% nominal returns compared that of 16.5% 5-year annualized returns of S&amp;P 500. UK Equities barely keeps pace with inflation, essentially eroding the purchasing power of retirees' savings. Pension funds are said to have averaged under<a href="https://getpenfold.com/news/pension-interest-rates" rel="noopener noreferrer" target="_blank"> 7%</a>. Alternative investments such as private equity (PE) has traditionally been generating<a href="https://www.klarphos.com/news-insights/a-simple-case-for-alternative-investments-to-enhance-portfolio-returns#:~:text=The%20study%20found%20that%20private,funds%20had%20an%20approximate%20historical" rel="noopener noreferrer" target="_blank"> 15-24% annualized returns</a> historically. Added to that the tailwind behind alternative investing makes it almost mandatory to have strong alternatives exposure. A breakdown of key advantages to add alternatives exposure:<ul><li>Diversification: Traditional equity markets are consolidating, meaning there are fewer publicly traded companies to invest in (listed equities have come down from 8000 in 1990s to less than 3700 today). Alternatives offer diversification, spreading risk and providing access to value creation in the private sector. Companies are staying private for longer periods, and a lot of the value creation is happening in private markets.</li></ul> <ul><li>Riding the Digital Wave: Many industries are undergoing a digital transformation, and a significant portion of the value generated from this shift resides in private markets. By incorporating alternatives, pension funds can gain exposure to these high-growth areas.</li></ul> <ul><li>Non-Correlation: Studies suggest that alternative asset classes have a low correlation with traditional investments.. This means that when traditional markets experience a downturn, alternatives may hold steady, further enhancing the overall resilience of a pension fund's portfolio. There is an alternative argument however that the private markets simply delay downsizing their valuations. But what matters ultimately is the returns upon exit, something to watch out for.</li></ul> Learning from the Pack:North American pension funds have been at the forefront of incorporating alternatives into their investment strategies. European funds are slowly opening up and developing expertise in selecting skilled fund managers and accessing the most promising markets for alternative investments. While maximizing returns remains paramount, strategically incorporating alternatives offers pension funds a powerful tool to fulfill their core mission: securing a comfortable future for retirees. However, navigating the alternatives industry is no easy task. There is much work to be done both from pensions funds and the alternatives industry overall. Alternative industry is famously complex, lacks transparency, has high fees, boasts of limited liquidity, and is ridden with regulatory restrictions. In addition, market timing is crucial as performance can vary significantly with economic conditions. By carefully selecting managers and diversifying with alternatives, pension funds can unlock higher returns, achieve better portfolio balance, and tap into the growth potential of the private sector. This, in turn, can translate to a better financial future for generations of retirees. References:<a href="https://www.theguardian.com/business/article/2024/jul/12/british-chipmaker-graphcore-bought-by-japans-softbank" rel="noopener noreferrer" target="_blank">Talent drain in the UK if pension funds don't invest locally</a><a href="https://getpenfold.com/news/pension-interest-rates" rel="noopener noreferrer" target="_blank">How pension interest rates work?</a><a href="https://www.klarphos.com/news-insights/a-simple-case-for-alternative-investments-to-enhance-portfolio-returns#:~:text=The%20study%20found%20that%20private,funds%20had%20an%20approximate%20historical" rel="noopener noreferrer" target="_blank">An aerial view of major alternative asset classes</a><a href="https://ifs.org.uk/publications/challenges-uk-pension-system-case-pensions-review" rel="noopener noreferrer" target="_blank">The case for UK pensions review</a><a href="https://ifs.org.uk/publications/challenges-uk-pension-system-case-pensions-review" rel="noopener noreferrer" target="_blank">Should pension funds invest in UK growth?</a><a href="https://www.hamiltonlane.com/en-us/insight/staying-private-longer#:~:text=There%20is%20growing%20evidence%20that,the%20sphere%20of%20public%20markets." rel="noopener noreferrer" target="_blank">Staying private longer leads to opportunity</a><a href="https://www.hamiltonlane.com/en-us/insight/staying-private-longer#:~:text=There%20is%20growing%20evidence%20that,the%20sphere%20of%20public%20markets." rel="noopener noreferrer" target="_blank">2024 pension updates from UK Spring budget</a>

Should pension funds invest in PE/VC?

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