Long-term asset funds (LTAFs) and investment trusts: the pros and cons of both
Investors have long made use of a wide range of investment trusts focused on private markets. Recent regulatory change and innovation is bringing a wider choice, including the open-ended LTAF.
There is a strong case for private investors to add exposure to private assets. Indeed, it is arguably stronger than ever. The return and diversification potential are compelling in their own right, before we get to that fact investors can access a broad range of investments not readily accessible through traditional public markets.
Where there is less consensus is how to achieve that exposure.
For many years investment trusts – funds structured as companies with shares quoted on the London Stock Exchange – have offered a route for investors seeking exposure to a range of private asset classes.
Recently alternatives to the investment trust structure have been developed – such as the long term asset fund (LTAF) - offering private investors and their advisers more choice.
With no two clients alike, we believe the widening of investor options is a positive development, and that LTAFs and investment trusts can play different - even complimentary - roles.
What is driving greater access to private markets?
A number of factors are helping to drive the expansion of options for investors and supporting growth in private markets.
- Central government focus
The UK government’s Mansion House Reforms aim to “unlock capital from the private sector delivering growth not by subsidy, but by increasing support for entrepreneurs and investors who take risks to create long term value”. The long-term goal is to open up new pools of private capital in the UK available for investment into pioneering businesses and essential infrastructure, helping to grow the economy.
- Regulatory support
The Financial Conduct Authority (FCA) wants “investment in long-term illiquid assets to be a viable option” for a wider range of investors “seeking the potential for higher long-term returns in exchange for less or no immediate liquidity”1
- New fund structures, such as long-term asset funds (LTAFs)
The LTAF is a new category of FCA authorised fund, which is open-ended, evergreen and specifically designed to allow a broader set of investors to invest efficiently in long-term, illiquid assets.
- Technological development offering new access points
Tokenisation, innovative private markets platforms and trading venues are a few examples of the growing number of new and fast-evolving delivery mechanisms breaking down traditional barriers to private markets access.
Investment trusts and the benefit of liquidity: the ability to cash in
Investment trusts (ITs) have existed for more than 150 years. They are the oldest form of collective investment and can claim to be the original vehicles to “democratise” investment. The alternatives-focused IT sector alone has grown to almost £100 billion according to Numis research, offering the wider public the opportunity for ownership in a selection of private investments including private companies, infrastructure projects and real estate. They also continue to evolve, remaining highly popular both with direct private investors and wealth managers overseeing client portfolios2.
As a result, many asset managers, including Schroders, are committed to investment trusts and are helping grow the sector. We expect them to continue to play an important role for several reasons.
Liquidity for most investment trusts of reasonable scale, in normal market conditions, is good. This is a major factor in their favour.
Fans of investment trusts point out that the closed-end company structure is well suited to house illiquid assets. It has helped them weather market storms which have proved more difficult for open-ended structures, such as unit trusts or open ended investment companies (OEICs).
There have in the past been instances of open-ended funds holding illiquid assets that couldn’t be sold to meet investor redemptions, leading to what are called “liquidity mismatches”. New open-ended structures, such as LTAFs, have been specifically designed with these episodes in mind, a subject we’ll look at a little later.
With listed funds such as investment trusts, the trade-off for liquidity is that the share price moves independently of the stated underlying investments’ value (“net asset value”, or NAV). Some investors favour the structure for this reason, as it allows for daily liquidity and offers the potential to buy at a discount.
Discounts are used by some investors to tactically adjust their holdings to seek higher potential returns. That said, while discounts can provide attractive buying opportunities and liquidity in ITs is valuable, there are no assurances that the discount will narrow.
The liquidity benefit of investment trusts is well understood, and investors definitely find it reassuring. But in practice, being a seller at the wrong time can still result in failing to get a reasonable return for your holding over a long hold period. There might be an exit, but that doesn’t mean it will be fair.
Launching LTAFs – Bringing more of private markets to investors
LTAFs are a new type of FCA-authorised open-ended fund specifically designed to facilitate investment in long-term, less liquid assets, but for a wider investor base that can include retail investors.
The FCA has designed the LTAF structure, to help mitigate potential liquidity mismatches mentioned above, while still connecting capital to economically supportive initiatives. According to Simmons and Simmons, the law firm, “this is achieved by providing a high level of investor protection and an alignment between the liquidity of the asset base with the frequency of redemptions offered to investors through the deployment of carefully considered liquidity management tools.”
Opportunities to invest in such open-ended private asset structures are already available to eligible, sophisticated investors, but to date have been out of reach of most UK private investors.
The LTAF now seeks to widen that audience in the UK, especially with recent regulatory rule changes that will allow eligible retail investors to participate. This is an especially important development for private client business providing discretionary and advisory services to retail investors, who will now have a greater choice when allocating to private markets.
While ITs continue to serve many investors very well, there are some places in which LTAFs may excel in meeting investor needs. In particular, where an end investor has a long-term time horizon and can therefore take on some degree of illiquidity.
LTAFs, by trading at NAV, are not susceptible to discounts moving against investors at the wrong time. While this comes at the cost of the level of liquidity ITs can offer – and the tactical trading opportunities - it offers private market exposure that acts in a different way in a portfolio.
Discounts can for example, be especially large and volatile for investment trusts where the underlying assets are illiquid in times of stress. This price volatility can be problematic for investors who are buying private assets trusts as portfolio diversifiers.
While data on NAVs shows consistent diversification between private asset vehicles and liquid benchmarks, diversification data on IT share prices shows this to be diluted (or eradicated) during periods of higher market stress. LTAFs preserve the diversification qualities of private asset holdings by removing this exposure to short-term market volatility.
The ability of ITs to raise new capital to support new investment pipeline can also be hindered by persistent discounts. On the contrary, the ability to raise capital in line with investor requirements means LTAFs are more easily “scalable”. Larger wealth managers, for example, who can struggle with risk limits on smaller ITs, could factor the use of LTAFs into more client portfolios than might be the case for investment trusts.
Finally, where IT launches (Initial Public Offerings) can be expensive, reducing day one NAVs for founder investors, LTAF launches are typically lower cost to investors. They are also able to be scaled over time and offer less “blind pool risk” than traditional private funds and ITs at launch. Of course, again, the trade-off here is the certainty of liquidity. LTAFs are structured to align redemption terms to the underlying “natural liquidity” of the portfolio assets, among several other built in liquidity measures. This is a key area where LTAFs differ to previous open-ended structures. Therefore, at scale and in normal market conditions they should still provide reasonable liquidity - 5% of NAV per quarter could be expected.
Scaling the private markets opportunity set, how LTAFs can help
An additional and essential part of the LTAF discussion, is the growth of the private markets and how investors can better access this expanding opportunity set. This is especially, important as the universe of listed companies traded on stock markets is shrinking.
As a listed sector, investment trust’s have seen huge success in raising new capital over the last decade, but are not immune to the cyclicality of public markets. When IPO and issuance markets are shut, generally in times of market uncertainty, LTAFs remain in position to raise capital as per investor demand.
Data tells us that capital deployed in recession years can often be amongst the strongest periods for returns, but these are generally times that the trust market can’t raise new capital.
The LTAF structure helps solves this issue. Open ended, they can raise capital when the best opportunities are available, and return capital to investors in normal market conditions, as required.
Maximising the number of positive client outcomes
We remain strongly of the opinion that investment trusts will have a significant role to play for clients as the private asset market continues to democratise and evolve. However, a wider range of options to gain exposure to private markets increases the likelihood of delivering against a specific client need, and we are confident that rather than one trading off against the other, we’re likely to see ITs and LTAFs used side by side as investors increasingly fold private exposure into portfolios.
This piece is the second in a series examining LTAFs and other ways wealth managers and their clients can access private markets. In the next and final piece, we will look in detail at the LTAF’s liquidity management processes.
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3Source: AIC databank, August 2023. 11 out of 17 trusts in the private equity sector have a five-year average discount >20%.
4Source: Centre for Policy Studies. Retail therapy: making the case for wider share ownership, July 2023