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How the need for enhanced returns and the search for new avenues to raise capital has reshaped the alternative market dynamics
By Antonis Anastasiou, Head of Product Development at Alter Domus as published in Insight Out #27
2022 has been a difficult year for capital raising for PE funds showing a decline of 11% in comparison to the 2021 all-time high, according to Preqin data. This has been due to the decrease of LP commitments and Institutional investors reducing their exposure by approximately 3%. Interestingly, a new market has been forming by private individuals and wealth managers demand for diversification and higher returns. As such, GPs and Managers have been forced to seek fresh means of accessing capital to support new vintages.
Mix into this dynamic new regulatory enhancements which have enabled the creation of “Hybrid Funds”. These are effectively the traditional alternative fund strategies we know however incorporating open-ended features and accepting retail investors. This ‘retailisation’ of alternative funds is a term now widely utilized within the industry.
These favourable regulatory adaptations can be a game-changer. For instance, the European Long Term Investment Fund 2 regulation (“ELTIF 2.0”) has been met with positive reactions from both investors and managers.
The new regulatory landscape and ELTIF 2.0
The adoption of the new regime in Europe was completed in April 2023 and comes into force in January 2024. This will replace the existing ELTIF regulation, which has struggled to find its place within the structuring toolbox of Fund Managers as a viable solution. Similar adoptions can also be seen in the rest of the world with the Financial Conduct Authority (FCA) developing the open ended LTAF funds, and in the US defining “accredited investors” which enables certain investors with a level of sophistication warranting a reduced need for protection to invest in alternative products.
The original regime however failed to obtain significant traction with only 83 funds launched. This was predominantly driven by the high level of restrictions which reduced the flexibility that alternative strategies need to flourish.
The much-anticipated ELTIF 2.0 regime has taken a step in the right direction by making it a more attractive vehicle for addressing the “retail market” for alternative asset managers. Key impacts on the PE world include:
– Funds can now be structured as open-ended Funds with a minimum annual subscription and redemption opportunity
– The removal of the 10 million minimum value threshold for eligible real assets; opening up investment opportunities
– The minimum threshold for investments into eligible assets has also been reduced from 70% to 55%
– It’s now possible to invest into other EU AIFs and not just other ELTIFs hence liquidity management can also be addressed through AIFs with similar strategies to manage the liquidity requirements
– Rules on distribution have enabled the use of a marketing passport across the EU and now allow for retail investors (additional restrictions apply if purely marketed to retail investors)
These “Hybrid Model” setups will require a shift in mentality and operations for both service providers and asset managers:
For Administrators this will require a variety of tools that are able to manage funds with open ended features which were primarily associated to the UCITS world. Additionally, there is a need for systems that can handle portfolio accounting for both illiquid and liquid assets.
For Depositories, the retail regime is geared towards optimal protection of the investors, insofar that only Banks can operate as Depositary for the ELTIF 2.0. This will open the road for specialized banks who will need to blend liquid and illiquid setups together to manage these hybrid funds.
For asset managers there will also be a steep learning curve in managing investors with liquidity requirements that PE firms are unfamiliar with. This could lead to the need for restricted redemptions, highlighting the complexity of incorporating such liquidity measures into their portfolio.
With these challenges comes the added value that such structures benefit:
1) GPs/Managers by paving the road to new distribution channels reaching both Private and Professional investors and
2) Pension and retail savings funds seeking diversification and better returns in an asset class which initially could have been out of scope.
The looming AIFMD 2.0 could however incorporate new limitations, but as of now the ELTIF 2.0 has been branded by many as the new UCITS for Alternative Funds.
The Luxembourg advantage and where we go from here
The success that Luxembourg has had over the last 30 years has undoubtedly enabled the country to become one of the most established Fund domiciles globally. The initial drive for this success was through the retail funds world in UCITS. The adoption of the AIFMD in 2013 has opened the space for alternative managers to replicate their strategies and develop a market for professional and institutional investors as well. This has further solidified Luxembourg as the go-to country for the launch and management of Funds.
The level of stability, history and services available in Luxembourg also makes it a prime mover in the domicile of these new Hybrid ELTIF 2.0 Funds. It offers both the regulatory supervision and comfort for investors as well as a plethora of established names in service providers which have adapted over the years to meet clients’ and investors’ needs.
Additionally, within its own structuring toolbox, Luxembourg already has the approved UCI Part II Funds (17 Dec 2010 Law). These funds offer eligibility in all types of assets, however, distribution can only be to professional investors but could accept any type of investor into the fund. In theory, therefore, retail investors could also enter the fund.
With a broader product line and willingness to service these type of hybrid funds as shown by the adoption of the original ELTIF regime, Luxembourg clearly places itself as the primary location for the development of the ELTIF 2.0 Funds. This is further enhanced with a booming retail and alternative offering, a successful history, readily available staff, and first-class service providers. Ultimately, it has the expertise for the development and success of the retailisation of the alternative Fund Industry.
