A new breed of fund structure is rapidly emerging, namely one which blends the best characteristics of both open ended and closed ended funds. With investors desperately seeking out returns , these semi-liquid funds are becoming increasingly popular, as Louis Lamotte explains.
On the scramble for returns
Traditional equities and bonds have not met the performance expectations of many retail investors, and this is forcing people to look for returns elsewhere. As one of the best performing asset classes, private market strategies should be a natural fit for most retail investors.
According to Pitchbook data, private equity funds generated 10.5% in 2023, whereas private debt registered a rolling one-year internal rate of return (IRR) of 9.2%. [1] Despite the attractive yields, retail investors have found it notoriously difficult to access private market funds, as these products are only really available to institutions. This is slowly starting to change, however.
A middle ground emerges
For private fund managers , the retail market is a massive untapped commercial opportunity.
By winning more retail mandates, managers will be able to diversify their client portfolios, reducing their dependency on big institutions for money. Nonetheless, conventional private market funds are not suitable for the retail pallet, which is why managers are starting to develop so-called semi-liquid funds.
Like private market funds, semi-liquid funds will invest in illiquid assets, but unlike private market funds, they will not lock up client money for years at a time. Instead of the standard private equity 8-10 years lock-up period, a semi-liquid fund will provide its investors with quarterly or bi-annual redemption terms, allowing customers to strike a sensible balance between liquidity and access to higher-returning assets.
ELTIFs versus LTAFs versus Interval Funds
Semi-liquid funds are becoming more ubiquitous globally. This is partly because governments want retail investors to plug the funding void facing large-scale infrastructure projects, which has prompted a number of regulators to develop semi-liquid fund structures.
The EU has been especially active here.
First launched in 2015 and part of the much-vaunted Capital Markets Union (CMU) programme, the European Long Term Investment Fund (ELTIF) was initially a closed ended fund vehicle which gave investors access to illiquid assets such as infrastructure, real estate, private equity and long-term projects.
Due to the prescriptive rules on investing, ELTIFs were not an instant hit with retail audiences. After six years, there were only 57 ELTIFs operating across four member states, managing just €2.4 billion between them, a figure dwarfed by the €6.8 trillion controlled by EU AIFs. [2]
EU regulators have since amended the ELTIF regime, i.e. broadening the range of eligible investments, removing minimum investment limits, allowing funds to be semi-liquid, etc, making them more attractive for retail investors, an approach which so far seems to be working.
The proof is in the pudding.
At year-end 2023, the number of ELTIFs stood at 95, with a total AUM of €13.6 billion. [3] Looking ahead, experts reckon that ELTIFs could potentially grow their market share to €30 billion to €35 billion by 2026, [4] and possibly €50 billion by 2028. [5] Just as UCITS became the global standard bearer for mutual fund products, we expect ELTIFs will do the same for semi-liquids.
Semi-liquid funds are not just unique to the EU. In the UK, the government-backed Long-Term Asset Fund (LTAF) has been making waves among retail investors and pension schemes alike. Similar to the ELTIF in many respects, the LTAF is also a semi-liquid fund by design .
Although these products have yet to accumulate as many assets as ELTIFs, a handful of leading fund managers – including Schroders and Aviva – have since launched LTAFs, suggesting a strong vote of confidence in the product.
The US also has a burgeoning semi-liquid fund market.
Launched in 1993, interval funds provide retail investors with access to illiquid assets, but also allow them to redeem a portion of their shares on a regular, i.e. quarterly, basis. According to Morningstar data, interval funds’ AUM has grown by 10% annually over the last decade, with managers currently looking after $80 billion. [6]
Withstanding the challenges
Although semi-liquid funds could help managers raise plenty of capital, they are not without their challenges.
Operationally, managing liquidity in a semi-liquid structure can be very complicated, often requiring careful planning and risk management, so as to avoid any liquidity mismatches. Ensuring periodic redemptions are met means that firms need to have the right operational infrastructure – together with sophisticated investor communication strategies – in place.
In contrast to publicly listed securities, valuing illiquid assets can be difficult due to the underlying assets’ complexity. If errors are made during the valuation process, then this can have serious implications for pricing transparency and ultimately investor confidence.
To prevent these sorts of risks from happening, managers need to work with experienced service providers, who can help them navigate the various pitfalls that come with running semi-liquid funds.
Engaging with organisations like JTC Group – who support semi-liquid funds with everything from fund administration, regulatory compliance right through to investor reporting and liquidity management – will make a significant difference for firms operating in this space.
This article was first published in Funds Europe.
References:
[1] Pitchbook – August 30, 2024 – For private debt funds, the good times keep rolling
[2] European Parliament – Amending the ELTIF regulation
[3] Scope Explorer – May 15, 2024 – Solid growth in ELTIF market: New regulation to drive further expansion
[4] Scope Explorer – May 15, 2024 – Solid growth in ELTIF market: New regulation to drive further expansion
[5] Private Equity International – November 29, 2023 – ELTIF adoption expected to gather momentum in 2024
[6] Lord Abbett – July 18, 2024 – Interval funds: Five potential benefits for investors
