Why choose an LTAF for investing in renewable infrastructure?
There are more opportunities for UK defined contribution pensions to access renewable energy investments today. We look at how LTAFs fit the bill.
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In a more complex macro environment, pension savers are on the look out for uncorrelated sources of returns to support the different phases of retirement.
UK defined contribution (DC) pension schemes, like private investors, have historically had limited options to diversify away from public markets, unable to tap into many high-quality opportunities in private markets.
These include investments such as direct holdings in energy transition-related infrastructure, which offer the potential for higher returns, portfolio diversification, and material benefits for the environment and society, as well as energy security. You can read more about the potential benefits of investing in energy transition infrastructure by reading our recent white paper.
Today, new fund structures are being offered to allow a broader set of investors to access these types of investments. DC investors are responding to this newfound opportunity, and we are seeing increased demand for assets which both address the energy transition and provide a differentiated risk profile for investors’ portfolios.
Here we explain how pension savers can access the energy transition investment opportunity, and why the open-ended evergreen structure of long-term asset funds (LTAFs) makes sense.
Why energy transition infrastructure?
The International Energy Agency (IEA) estimates that around $4.5 trillion per year needs to be invested into the energy transition from the early 2030s, an almost three-fold increase from 2023, itself a record year. A large proportion of this capital will be directed to traditional renewable energy assets such as wind farms, solar power plants and hydro-electric plants, but capital is also being invested into areas such as green hydrogen production, battery storage and large-scale heat networks.
While the sustainable outcomes are undeniable, the economic advantages are the primary reason these investments are an attractive option for well-structured investment portfolios. This is particularly the case for DC members, where the energy transition presents an opportunity for significant diversification versus listed equities, while at the same time offering the potential for substantial returns, supported by high, stable and predictable cash flows.
What is an LTAF and how is it structured?
Approved by the FCA in 2021, the LTAF is type of UK-authorised open-ended fund designed to invest in long-term, illiquid assets, while providing appropriate structures to reflect the reality of DC schemes, where funds require greater flexibility to meet the needs of members as they approach retirement.
“Open-ended” means funds can grow to accommodate new investor demand by issuing new units. Funds also provide periodic liquidity mechanisms that enable investors to withdraw money by redeeming units in the fund, according to agreed rules (see below). The aim of the LTAF is to broaden options for investors looking to build their retirement pots, through access to such investments as energy transition infrastructure that would previously have been difficult to access.
Investors in an LTAF buy and sell units at the prevailing net asset value (NAV) of the fund. Entry and exit points (subscriptions and redemptions – and the rules around them) have been developed to provide liquidity in a controlled manner. For example, subscriptions and redemptions are offered monthly or quarterly (commonly monthly for subscriptions and quarterly for redemptions), and there is typically with a cap on how much can be redeemed at any given time, often set at 5% of total NAV.
A well-constructed fund portfolio, diversified by geography, sector and asset type, and with a potential small allocation to liquid investments, such as listed equities and cash, can engineer a level of “natural liquidity” that is regular and consistent. LTAFs also employ management tools to control liquidity within the fund, such as the aforementioned redemption limits and realising liquid investments.
Why does an LTAF make sense for the energy transition?
Investing into illiquid assets is new to many investors, and the LTAF has been designed to deliver on the key characteristics that investors seeking exposure to energy transition infrastructure may require. For DC investors, having a degree of flexibility around liquidity helps to overcome some of the traditional hurdles to investing in these assets.
Ultimately, the major benefit of an LTAF structure is the ability to access high quality and differentiating assets in an appropriate format. In the case of energy transition infrastructure, investors can benefit from its risk and return characteristics, which can contribute to better portfolio outcomes, and access the attractive entry point on offer in the market today.
How should investors assess the liquidity profile of energy transition infrastructure investments via an LTAF?
The energy transition is a long-term theme, and investors in this space generally have a long-term mindset. However, we recognise investors’ needs change over time. While renewable infrastructure investments are typically considered illiquid, open-ended evergreen funds strike a balance by providing regular access to liquidity. Trustees and pension managers can manage the liquidity exposure with the flexibility provided by periodic subscriptions and redemptions at the fund’s NAV.
It’s important to highlight that even if LTAFs offer periodical redemptions, these are not as frequent as in mutual funds, which offer daily liquidity. Redemptions are managed through a combination of factors; the high level of cashflow delivered by energy transition assets, a modest holding of liquid assets and, if needed, the ability of the fund manager to sell stakes in energy transition assets to the large and growing marketplace of buyers and sellers.
The energy transition is constantly evolving; how should the mix of assets in a portfolio evolve over time?
The "evergreen" open-ended structure of LTAFs enables continuous investment in the fund, allowing investors to see their money put to work immediately. Their subscriptions (the entry point) are added to the existing pool of assets and used to purchase more assets to broaden the overall pool.
This method enables the existing investors to benefit from potential growth and returns from the purchasing of new assets in the portfolio, while allowing newer investors to get access to a diversified portfolio from the first day of their investment. It also means managers can make new investments that take advantage of market dynamics as they evolve through the cycle.
What are the key considerations in relation to fees?
Fee structures vary among LTAFs, but due to increased regulatory scrutiny and the emphasis on transparency, fee information needs to be clear. Investors are generally given a full look-through to all the fees paid to the manager, and so, elements like a transaction fee (where a manager is paid an additional fee for buying or selling assets) are visible. Similarly, some managers charge performance fees over and above the fees already mentioned, and in an LTAF these need to be disclosed.
Our approach with respect to fees is to make them not only competitive, but as transparent as possible.
LTAFs and the energy transition
Overall, investors who consider an investment in the energy transition need to understand that, in order to maximise the benefits, it is crucial to view these as long-term investments. Therefore, allocations should be considered in the context of investors’ objectives, liquidity needs and risk tolerances. This is aligned with the nature of renewable infrastructure assets.
While this article has discussed the benefits to this structure, there is no such thing as a free lunch. Investors should be aware that holding liquid assets (cash and listed securities) means this is not a ‘pure’ energy transition exposure. It is, however, an innovative way to access the benefits of energy transition infrastructure within a fund structure that is more appropriate for investors that require greater flexibility with regard to liquidity.
Equally, energy transition assets are illiquid assets, and while an LTAF does enhance the liquidity options available to investors, there are limits to what can be delivered. Having a controlled limit on redemptions does introduce the risk of gating within these structures, and ultimately, in truly difficult markets there is the potential need to further limit redemptions to protect investors. Both should be considered by investors when sizing the LTAF positions within their broader portfolio.
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