For a long time, managers of open-ended funds looking to invest in real estate and other long-term assets have struggled with the short notice redemption requirements of open-ended funds. This is because traditional open-ended funds require a manager to allow daily dealings without notice, which create a liquidity mismatch if that fund is holding, among other assets, long-term and illiquid assets. This mismatch has created negative headlines for some managers who have been forced to close open-ended real estate funds to further redemptions due to the volume of redemption requests and falling property values.
Closed-ended structures such as investment trusts and limited partnerships have, traditionally, been the used as an alternative vehicle for investment in long term assets such as real estate, however, the perceived lack of liquidity in these vehicles have put some larger institutional investors off investing.
To address this problem, in their Consultation Paper 21/12 (CP 21/12) the FCA have added a new category of authorised fund known as a Long Term Asset Fund ("LTAF") to allow efficient investment in long-term, illiquid assets with appropriate safeguards. We've highlighted the key features of an LTAF below.
- What legal form can an LTAF take?
An LTAF can be established as an Authorised Unit Trust, Authorised Contractual Scheme or an Investment Company with Variable Capital (also known as an open-ended investment company). Very importantly, the FCA has deemed that an LTAF is to be treated as a non-mainstream pooled investment ("NMPI").
- Who can LTAFs be marketed/promoted to?
As an NMPI, LTAFs can only be promoted to professional clients and not retail clients. However, an LTAF can be promoted to exempt individuals such as certified high net worth individuals, certified sophisticated investors and self-certified sophisticated investors. The full list of exempt persons can be found can be found at COBS 4.12 of the FCA Handbook.
- Investment powers of an LTAF
An LTAF must invest mainly in "long term illiquid assets". The FCA have said that they have kept this definition relatively broad but have said that an LTAF should invest at least 50% of scheme property in unlisted securities and other long-term assets. In COLL 15, the FCA have set out the list of what types of interests an LTAF can invest in and includes (but not limited to) loans, real estate, precious metals and specified investments. The manager must also ensure that the objectives, policy and strategy of the LTAF's scheme property provides a "prudent spread of risk". Similar to the definitions of illiquid assets above, the FCA have not given prescriptive or detailed guidance on what constitutes a prudent spread of risk but that the FCA have said that the word "prudent" should be given its ordinary natural meaning.
- Borrowing powers of an LTAF
An LTAF's borrowing must not exceed 30% of the net asset value of the scheme property. This has been the usual requirement for authorised open-ended funds.
An LTAF must be managed by a full-scope UK AIFM. The manager must also have the knowledge, skills and experience to be able to understand the activities and in particular, the main risks involved in those activities and the assets in which the LTAF have invested in.
There is a minimum 90-day notice period for redemptions to assist managers with liquidity balance. The FCA actually expects managers to implement much longer redemption notice periods in practice. Again, the period should be based on the underlying policy and strategy of the LTAF.
Valuations must be carried out monthly.
The manager of an LTAF must appoint an external valuer to perform the valuation function for the LTAF unless the manager has the knowledge, skills and experience of the assets being valued. If an external valuer is not appointed, the depository of the LTAF must also make an assessment on the manager's suitability to carry out the valuation function.
The FCA plans to reopen the discussion on the LTAF regime in the first half of 2022 and to specifically look into whether it is appropriate to widen their distribution to retail investors. If so, we would expect this to increase their popularity among fund managers and would provide a great opportunity for retail investors to gain exposure to long-term investments.
The funds team at Howard Kennedy would be happy to discuss the benefits of the LTAF and alternative options with any interested parties.