Podcast: Is this the fund to save the economy?

James Lowe, Sales Director, joins the pod to discuss LTAFs: their pros and cons and what areas of the economy they are set to benefit.

24/10/2023
Investor Download-ltafs

Authors

David Brett
Multi-media Editor
James Lowe
Sales Director, Private Assets and Investment Trusts

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You can read the full transcript of the podcast below:

[00:00:07.930] - David Brett

Welcome to The Investor Download, the podcast about the themes driving markets and the economy now and in the future. I'm your host, David Brett.

[00:00:24.890] - David Brett

Cash-strapped governments have been looking at ways of unleashing private investment to help finance much needed infrastructure projects, meet climate goals and boost flagging economies.

[00:00:35.230] - James Lowe

There's definitely a focus from governments around the world to try and crowd in pools of private capital into areas of the economy that can help fuel economic growth.

[00:00:47.170] - David Brett

That's James Lowe, sales director at Schroders. The latest initiatives in the UK and Europe involve the creation of long term asset funds and the aim...

[00:00:58.450] - James Lowe

...to try and get more pensions' capital into private markets, particularly private equity, innovative companies in the UK to try and fuel new growth through new companies' development and hopefully grow some very interesting new innovative UK PLCs that will then eventually list on the London Stock Exchange.

[00:01:22.630] - David Brett

The schemes in the UK and Europe in some way mimic high profile plans that have long been in place in other parts of the world, such as the Middle East and North America. In this show, I speak to James about the UK's plan. We'll discuss the pros and cons, what can be learned from similar schemes in the rest of the world and how LTAFs might transform the economy.

[00:01:47.890] - Announcer

On Apple podcasts, Spotify, or wherever you get your podcasts you're listening to the Investor Download.

[00:01:54.890] - David Brett

James, welcome to the show. How are you?

[00:01:57.460] - James Lowe

Good, thanks. Thanks for having me on, David.

[00:01:59.490] - David Brett

No, no problem at all. From the looks of it, you, like me, are bunkered at home today.

[00:02:04.250] - James Lowe

We are indeed. Train strikes are a real thing. Hopefully we can all get back to work soon.

[00:02:10.710] - David Brett

Yeah, we just keep getting snookered by these train strikes. But we're not here to talk about train strikes, we're here to talk about something called LTAFs, which I would guess the majority of people outside the investment community probably don't know much about. They certainly don't know what it stands for. So let's start with the basics. Can you just let so what does an LTAF stand for?

[00:02:32.140] - James Lowe

Yes, so David LTAF is a long term asset fund. A long term asset fund. It's interesting actually, thinking back to some of the history of this. It started back in 2019 when Rishi Sunak was actually in the treasury, but actually didn't launch until 2021, and it's then taken us another couple of years to get to the point of actually having products in the market. So an LTAF is relatively new to a lot of people, although it has been around for longer than you might think. What it actually is is a new category of FCA, being the Financial Conduct Authority, the financial regulator in the UK, authorised fund. It's open ended in nature, it's also evergreen, so it invests perpetually. And it's really been designed to specifically allow a broader set of investors to invest efficiently in long term illiquid assets. And when I say illiquid assets, I'm generally talking about private assets like private equity, venture capital, infrastructure and private debt.

[00:03:35.500] - David Brett

And what would be the one line pitch you might put to a retail investor as to what an LTAF is?

[00:03:41.910] - James Lowe

So it's a good question, and it's one of those questions which it's difficult to answer at this point in time because we don't actually have any retail LTAfs yet. So I would be pitching something that's hypothetical here, but I will give you a pitch. So, just taking a step back, where does the LTAF fit for a retail investor? If you look at how the UK private asset ecosystem has developed over the last few years, what we had about five years ago is two key structures. We had the investment trust, which a number of the listeners might be more familiar with, that's a closed ended daily dealing fund, and a number of them do invest into private asset and illiquid investments. And that's been a great vehicle for retail investors to be involved with private markets development over the last number of years. The other structure we had was a very institutional structure, which is called a limited partnership structure, and that's a structure that lots of pension funds and bigger institutions are using. But it means that you have to lock up your money, invest it for a long period of time with no access to it, generally over a ten year period.

[00:04:51.060] - James Lowe

So not so applicable to retail investors. What the LTAF is is somewhere in the middle of this. So it doesn't give you daily dealing where you can trade it on an exchange like an investment trust, but it also doesn't lock your money up for a very long period of time. So what we have here is a structure the FCA is now approving and bringing to market for retail investors that sits in the middle. And so it's what we call a semi liquid, somewhere in the middle of liquid and illiquid, which makes a lot of sense, private asset vehicle.

[00:05:25.660] - David Brett

Okay, like you said, we do have investment trusts and other vehicles within the market that do already invest in private assets. So why do we need LTAFs?

[00:05:33.810] - James Lowe

So that's a really good question. I think it goes back to my comments around where this sits in the UK market ecosystem. I think it's useful to take another step back here and look at the development of private markets and why we need sort of a broader selection of structures for investors. We've gone from at the start of the 2000s market that was sub $1 trillion globally in value, which has now increased over tenfold to $13.5f trillion dollars of AUM. So we've seen huge amount of growth. Within that growth we've seen new structures emerging. We're using old structures like investment trust, but we're also now seeing new structures like the LTAF. Why do we need new structures like the LTAF? There's a couple of reasons, and it really comes down to what consumer preference is and then you start getting to a conversation of what are the pros and cons of each types of structure. So if you look at an investment trust, for instance, if you're an investor that wants daily trading, daily liquidity and also access into private markets, then that is a fantastic vehicle to put your money into and it makes a lot of sense.

[00:06:45.650] - James Lowe

The downside of an investment trust for an investor is that you also get volatility. So the price is set by supply and demand dynamics in the markets on an exchange. And so in the time where you want your private market allocation to be diversifying for you and to give you a different type of movement to what you might have in your public equity allocation, for instance, you do generally find an investment trust that the investment trust market moves quite in track with what you see in the global equity market. It's what we call global or public equity market beta in the industry. So what does an LTAF therefore provide you that you can't get at an investment trust? LTAFs are different because they get priced at the net asset value, the NAV, of the underlying asset base. So you get a performance within an LTAF that much more closely tracks the underlying performance of the actual asset base. So in periods where the equity market sells off or the bond market sells off, you should see a slightly different based on historical returns. Obviously we can't forecast what's going to happen going forwards. You should see a slightly different type of return profile that you wouldn't get in the same way in an investment trust. So that's where it really fits in here.

[00:08:09.070] - David Brett

A more stable return profile or can it be just as volatile as public markets?

[00:08:16.030] - James Lowe

You would expect it to be more stable, but the thing to be aware of is that generally that these vehicles are going to be valued on a less regular basis. So on the investment trust side, you have daily valuation, continuous valuation on the exchange. Whereas in an LTAF, just to give you a bit of background to how these products will deal, you can only have at least monthly dealing on an LTAF, so you can only come in and out on at least the monthly basis. You can't do weekly. You can't do daily, which means that they're going to be priced on a monthly basis as the most frequent type of pricing, which means that you should see less volatility, at least intraday. It's not to say if you looked at the mark every month of an investment trust versus LTAF, it wouldn't be dissimilar. But you won't get that daily sort of price volatility that you would expect to see in an investment trust.

[00:09:15.600] - David Brett

Okay, and where's the demand for LTAFs come from? Has it come from investors themselves or from elsewhere?

[00:09:21.400] - James Lowe

Yeah. So the initial demand we've seen has been from the defined contribution market and that's really an outcome of where the regulations started. So the real focus at the outset of LTAFs back in 2021 was to try and open up the defined contribution market to private capital. And this is really one of those themes that the government has been sort of pushing more broadly at the moment around Mansion House reforms, where they're trying to find new pools of private capital in the UK to bring it into more productive finance mechanisms that can drive economic growth and also contribute to things like meeting our net zero targets. And one of the ways we're doing this is through trying to provide greater access to private markets through a different pool of investors, which is defined contribution pension schemes. So that's really where the demand has come from to start with. What's really exciting now, and quite a recent development, is that in June this year, the FCA (Financial Conduct Authority) published some new rules which effectively open up the access to LTAFs to retail investors.

[00:10:35.140] - David Brett

Okay, great. So I think we've explored LTAs and what they are fairly broadly there. In the next part of the show we're going to discuss why LTAs now and look at some of the pros and cons.

[00:10:44.030] - Announcer

Get in touch with us by email at schrodrspodcasts@schroders.com or visit our website, schroders.com/theinvestordownload.

[00:10:56.850] - David Brett

Okay, so James, in the first part of the show we looked at what LTAfs are now private investments, which is what you're saying is what LTAfs are mainly going to be guided towards. They seem to get a lot of attention in the mainstream media these days. Why is that the case?

[00:11:11.560] - James Lowe

I think it's to do with the growth of the market, really. We've gone, as I said, from a position where private markets were a relatively niche asset class. I mean, in 2000 they were under a trillion dollars of market value and through two decades we've gone through effectively a private market super cycle and we find ourselves at over 13 and a half trillion today. So what was once a relatively niche exposure in an investment portfolio is now very much a mainstream portfolio exposure, particularly in the institutional market where you see endowments, pension funds, sometimes with allocations to private markets that are over 20% in some cases. So it's just become much more mainstream. I guess the other point to make is the areas that private markets are touching are really important within the real economy. So things like the development of renewable infrastructure, the development of AI technology, social housing in the UK, there's lots of areas that are really important to the global economy and the UK economy that are being funded now through private capital in a way that they weren't two decades ago.

[00:12:28.700] - David Brett

What are the benefits of investing in, I suppose investing in the private assets, but via an LTAF?

[00:12:35.250] - James Lowe

There's a couple of key benefits of private markets that are often cited. Firstly, and I think one of the most interesting structural shifts we're seeing is the ability to invest in a broader range of investments than it's possible to achieve through public markets. And I think just using the US equity market as an example, what we've seen in terms of a trend in the US public equity market over the last 25 years is a halving of the number of publicly listed companies on the US exchange. Which means that effectively what's happened there is if you're a US public equity market investor, your universe has shrunken significantly. Now there's some very good reasons and they're not negative necessarily as to why that's happened. We've seen lots of M and A, so we've got a smaller number of large companies. We've also seen take privates as private equity companies with lots of dry powder have come in and taken some big companies, which have been all in the media, private. I think one other thing that is worth noting on this is that companies are generally staying private for longer, which means that there's less IPO activity in general, which means that there's less new companies going on to the exchange for various reasons.

[00:14:00.100] - James Lowe

Another stat I just sort of give you here, which I think is quite interesting and informative on this, is that if you look at all companies in the US which have revenue over 100 million, so highly revenue generating companies, 85% of them are in private markets. So I guess one of the reasons why you might think about investing in private markets in the US and public private equity in the US is because if you're not then you're missing potentially 85% of the universe and that's within a backdrop of a shrinking public equity market. That's one of the main reasons we think that institutional investors have been investing into private equity, particularly in the US, as an example there. One of the other reasons is diversification. So again, it follows as a logic that if you are able to invest in a broader range of economic exposures and different types of companies in a market through accessing the private companies, then you will be able to achieve more diversification in your portfolio. And if you look at correlations then that is something that is clear in the data. And also, just simply, if you look at long term historical return data, we have seen an excess return or a return pickup, a premium you could say, to public markets and private markets.

[00:15:22.000] - James Lowe

And again, you can see this in long term data and it's really one of the reasons as to why, again, institutions have been investing into private markets so substantially over the last 20 years.

[00:15:34.890] - David Brett

We've had some high profile cases, certainly in the press over the last few years, of funds getting themselves into trouble because they're investing in private assets. What makes LTAfs any different?

[00:15:47.550] - James Lowe

Yeah, this is a really critical question, particularly in the UK market context, where we've had a lot of noise around, quite rightly so, around open ended property which was daily dealing and then gated and sort of locked investors into the funds and we've also had Woodford. So those are two very sort of acute examples that we've had in the UK market which really hones the focus onto this as a topic. What LTAFs do is quite different in concept to what we saw in open ended property, using that as an example. So what we saw in open ended property was putting illiquid property assets into a wrapper that was investor friendly effectively, which was daily dealing and worked within the UK ecosystem. And that didn't work because you had a liquidity mismatch which effectively means that the dealing terms of the fund didn't match the ability to liquidate the underlying assets and get the money back so you could pay money out of the fund so they had to gate the fund. What the LTAF does is effectively turns that on its head. So the FCA within the LTAF rules mandates that you must align the underlying liquidity of the assets to the dealing terms and you've got to be able to demonstrate that when you go through the FCA approval process.

[00:17:12.410] - James Lowe

Risk in private markets has a very large spectrum in the same way that risk does in public markets. So if we look at investment risk, so returns and the volatility of those investments, there is a huge spectrum all the way from very high risk, early stage venture capital where you're taking a stake in an unproven, unprofitable company that you think is going to be the company of the future through to something that's much lower risk, like an operating wind farm in the UK, where there's government subsidies and you can model the cash flows out very nicely for the next 30 years. So investment risk in an LTAF and private markets context is, I say, very similar in terms of what you would see in public markets context where you can also invest in a low risk on portfolio or you can invest in an emerging market small cap equity fund. When you're looking at LTAF risk there are a range of risks you can take within an LTAF. The other risk then is illiquidity risk and that's one I think that sort of gets stuck as a badge on private markets as being the main risk. And I think that's where as an investor you need to think about what is your time horizon of your investment?

[00:18:29.710] - James Lowe

Can you take a long term time horizon? It's called a long term asset fund for a reason and that's because the expectation is that this is a long term investment for an investor. What LTAFs do do though is provide flexibility for investors to get out in normal market conditions. I think that's the big difference to what a lot of the institutional structures do, which they don't let you come out at. Think if you're thinking about what the risks are invested in this LTAF. Think about what the investment risk you might want to take is but then also think about what time horizon can I feasibly make this investment on and if I couldn't get my money out quickly would that be an issue? Because the reality is LTAFs are structured to get money out in a normal market condition but not when markets are all sort of falling away. And that's where if you think that's a problem you should be looking at the investment trust market because the investment trust market has got lots of great private asset exposure you get and you would be able to get out in any particular day if you needed your money back.

[00:19:39.280] - James Lowe

You just might get a really big discount to the net asset value and lose some money in that way. So as with all products and all markets there's a spectrum of risks, illiquidity investment risks and you've got to try and think about all these things when you're making these investments.

[00:19:56.570] - David Brett

So in the final part show we now know all the risks and benefits of LTAFs. We're going to look at what we might expect LTAFs to deliver in the future.

[00:20:11.170] - David Brett

So we've looked at the pros and cons of the LTAFs so what sort of areas are we talking about that LTAFs are more likely to invest into?

[00:20:20.180] - James Lowe

So it's still relatively early days on the areas that LTAFs will invest in purely because there's actually only three in market at the moment or expecting a number more to come before the end of the year. But one thing I think we're already starting to see is that Ltafts are likely to be more globally focused, highly diversified type products and one of the main reasons for that is that as you're trying to generate this underlying natural liquidity into portfolio you want lots of different cash flows coming from lots of different areas. So you're not exposed to a single shock in a single geography or asset class or sector. So what we're expecting to see is more broadly diversified global funds. To just give you a couple of examples of what we're seeing already. We've seen both multi asset so multi private asset funds which are incorporating a blend of private equity infrastructure, real estate, private debt, which is a very diversified global type portfolio that investors can invest into. But we're also seeing single asset class funds into, for example, renewable infrastructure. But that's also global, so globally over different countries. But what's important there is they're investing into different types of technologies.

[00:21:43.550] - James Lowe

So not just wind in the UK it's global wind renewables as well as solar and some energy transition assets, things like hydrogen for instance. So you're not exposed to any specific shock in one specific geography and technology and that's I think what we're likely to see in products going forward.

[00:22:03.110] - David Brett

And I suppose investors will be most interested in potential returns. Are we looking at a wide range of returns.

[00:22:10.510] - James Lowe

The type of returns you can generate across private markets are a huge spectrum. So it really depends on what asset class the individual LTAF is investing in. It goes back to the comments we made in the section on what are the sort of drivers of private markets and why should you invest? I think you're likely to see some products that are investing at the high risk end of the spectrum in things like private equity and in that sort of area, you're looking to generate higher returns than the public markets. A lot of the time these areas will be targeting, let's say, 15% IRRs all the way down to if you wanted to put together a very low risk but very cash flow, generative and reliable income type portfolio in real estate or infrastructure where you would be more at the sort of cash plus one or two type investments. There's huge range of returns. And I think what we'll start to see is lots of different products that are able to... Which will give consumers good choice as to the types of return profiles they want to include in their portfolios.

[00:23:31.410] - David Brett

Okay. Final question, James. You'll be pleased to hear, as we've mentioned before, at the top of the show, the UK and Europe are slightly behind other countries that already have these similar type of structures in place. So what can the UK and Europe learn from those countries when they start looking at unleashing these extra funds?

[00:23:49.290] - James Lowe

Yeah, I think you're completely right. If you look at other developed countries, there's definitely examples that we see globally where particularly more pensions capital is already involved to a greater extent in funding private markets and driving economic growth type processes in that country. So I think in terms of what the LTAF can do, I think it's part of a broader sort of package of measures which are coming in the UK. So LTAFs alongside what we heard in the Mansion House reforms are all part of a broader push to try and find new pools of capital, new supply of private capital that can be invested into either innovative companies that are driving technological change in the UK, building new infrastructure that's going to help us to hit net zero targets. Or as I said in one of my other examples, fund addressing social inequality in the UK through things like affordable housing or even private loans directly into social enterprises. So private capital is vitally important. I think you see that in what the government and the regulator are doing in terms of addressing a need for private capital to drive economic growth and productive finance in the UK.

[00:25:17.310] - David Brett

James Lowe, thank you so much for joining us. That was absolutely fantastic. And I look forward to when the first LTAF becomes available to retail investors. I think I might have a dabble.

[00:25:26.930] - James Lowe

I will too.

[00:25:28.390] - David Brett

Excellent. James though, let's speak to you soon.

[00:25:31.370] - David Brett

Well, that was the show. We very much hope you enjoyed it. If you want to find out more, please head to Schroders.com/insights and we're endeavouring to record as many of these shows in the studio on video. And if you want to watch them in their full unabridged version, then go to Schroder's YouTube channel. If you want to get in touch with us, it's Schroderpodcasts@schroders.com. And remember, you can listen, subscribe and review the Investor Download wherever you get your podcasts. New shows drop every Thursday at 05:00 p.m. UK time. But above all, keep safe and go well. Cheers.

[00:26:07.730] - Announcer

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Authors

David Brett
Multi-media Editor
James Lowe
Sales Director, Private Assets and Investment Trusts

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