IN FOCUS6-8 min read

How does liquidity work in an LTAF?

We explain what happens when investors want to redeem from a Long-Term Asset Fund (LTAF) and the mechanisms that manage liquidity.

06/02/2024
Multi-asset views

Authors

Peter Sankey
Product Manager, Private Assets

The LTAF is a type of UK authorised open-ended fund, designed to invest in long-term illiquid assets, while providing some flexibility for investors wanting to buy and sell. 

Liquidity management has been a key focus in the development of LTAFs. There are robust rules that govern this product ensuring investors can redeem their holdings at a price related to the value of the fund’s assets.  

The rules clearly dictate the parameters of liquidity mechanisms the LTAF manager employs, and the frequency at which redemptions are offered. 

We look closer into these mechanisms and how they work in practice. 

How liquid are LTAFs?

LTAFs provide access to investments, such as private assets, which are long-term and illiquid in nature. The LTAF uses innovative structures to provide flexible liquidity for investors who need to sell. For UK investors, the liquidity of LTAFs therefore falls between listed private asset investment companies (such as investment trusts which are daily tradable) and the more traditional limited partnership structures, which often come with a 10-year minimum lock-up.  

The LTAF rules establish that there should be consistency between the liquidity of a fund’s assets and its redemption terms. This is to align the amount of notice investors must give to redeem their investments and the liquidity of the underlying portfolio. 

The manager will build a portfolio which can deliver a level of “natural liquidity”. The yield or distributions from the underlying investments received by the fund, for example, should closely match the maximum level of expected investor redemptions in a steady market.  

The rules go further to state that LTAFs cannot permit redemptions more often than monthly and must have a notice period of no less than 90 days. Some LTAFs may even have longer notice periods and less frequent dealing. Again, the terms, which are set by the fund manager, must be consistent with the funds’ underlying liquidity profile.  

Liquidity mismatches can arise if open-ended funds invest in illiquid investments and allow too much flexibility on redemptions. It is a key focus for the regulator, the Financial Conduct Authority (FCA), and managers of LTAFs to prevent this.

How does the liquidity work?  

While the FCA has set out rules such as permitted investment and notice periods, it is up to the LTAF manager to decide the liquidity management methods for the fund. 

The regulator has been very clear in that “an LTAF should not expect to use, nor rely on, suspension as a means of managing fund liquidity” in normal market conditions.  

For the Schroders Capital LTAFs, liquidity management will be incorporated in two ways: 

  1. Portfolio construction and risk mitigation  

The portfolio must offer a prudent spread of risk to avoid concentration risk. For example, it might be exposed to a range of vintages to establish a baseline of “natural liquidity” through distributions. Some of our LTAFs and semi-liquid funds may also invest a portion of their portfolio into more liquid assets. Geographic, asset class and/or sectoral diversification reduces the risk of being exposed to shocks or events impacting liquidity.  

Another consideration for portfolio construction is the pace of deployment for new subscriptions and being able to accommodate changes in subscription activity. Typically, closed-end funds allow investors to make commitments which are called over a certain period.  

However, LTAFs are evergreen open-ended funds so subscriptions must be invested faster, and the volume of subscriptions might vary from one period to the next. This means that an investment manager must be confident that their investment platform is broad and deep enough to accommodate irregular inflows and invest quickly, whilst maintaining diversification.  

In an LTAF, the cash balance of the fund is actively managed by the investment manager. It is a function of the level of subscription and redemption activity, the pace of deployment and distributions from the underlying portfolio.  

2. Liquidity management tools 

Beyond an LTAF’s inherent liquidity and cash generative assets, there is a range of tools to ensure the portfolio continues to function as expected over the long term. This includes mechanisms that align the fund liquidity with the long-term nature of the assets that sit within, to protect investors in the fund.  

The key tools are: 

Redemption limit – As part of the LTAF framework managers can set limits on the total percentage of the overall portfolio redeemed at each dealing day. As an example, a manager might determine that 5% net redemptions per quarter is appropriate, giving an annual limit of 20% per year. This limit should be set in line with underlying liquidity of the fund’s portfolio, so it could vary from fund to fund. 

Notice periods – The LTAF framework requires funds to have a minimum notice period of 90 days. If redemptions exceed subscriptions for a given dealing date, the notice period gives the LTAF manager time to liquidate assets and plan for redemptions. 

Realising liquid investments – As noted above, LTAFs will typically hold a portion of their portfolio in liquid assets which can be sold more readily than the more illiquid assets if net redemptions are received at any dealing day. 

Secondary sales – Actively selling portfolio investments can also help to raise the liquidity level. For many assets classes, the secondaries market has become very deep and therefore more liquid than it was 10-15 years ago.  

Lock-up periods - The above tools are relevant to established funds. When a fund is new, there might be a period during which no redemptions are permitted to allow the portfolio to become established. For example, both our newly launched Schroders Capital Climate+ LTAF and Renewables+ LTAF have a three-year lock-up period from inception. 

What happens when an investor chooses to redeem their holding? 

Redemption requests are first netted off against subscriptions received in the same period. If the net of those flows is positive – there are more subscriptions than redemptions, then additional commitments and secondary purchases can be made in the portfolio.  

If there is a net outflow, it will be met by the fund liquidity as outlined above.  

If redemptions for the quarter exceed the established threshold, then the amount will be reduced pro rata to ensure every investor in the fund has been treated fairly. The amount not dealt will then roll into the next dealing day, where it will be treated equal to other redemptions received for that dealing day, unless cancelled by the investor.  

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Authors

Peter Sankey
Product Manager, Private Assets

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