Long Term Asset Funds: from past foundations to future predictions

Long Term Asset Funds (LTAFs) are increasingly in the investor spotlight. They were created to facilitate investment in long term and illiquid assets: private equity, credit, venture capital, real estate and infrastructure. These asset classes take a considerable time to mature and are illiquid until they do so. Obvious examples are social housing, hospitals, energy and renewable energy and transport infrastructure, including roads and bridges. Investment into these types of assets makes a lot of sense for the UK; for the government; and for investors.

LTAFs have been designed to attract and unlock long term, patient capital predominantly from UK pension funds in order to fund the infrastructure needs of the UK and create enduring sustainable income and returns for pension funds and other eligible investors. They could also boost the UK's private markets, widening the spread of attractive investment options at a time when the London Stock Exchange is facing immediate geopolitical uncertainties plus some underlying challenges (lower valuations than in the US, fewer flotations, less capital available).

It is hoped LTAFs will pave the way for private money to finance the country's real estate and infrastructure needs. Our social housing stock is old. Many of our hospitals are outdated. The public purse will not meet the entire need.

LTAFs may also have a part to play in financing the development of UK renewable energy. The UK's need for energy security is in the forefront of the government's concerns following the war in the Ukraine. Given OPEC supply restrictions, the political post-election agenda is still going to be focused on low carbon energy sources.

Key characteristics

LTAFs combine three very useful characteristics: (i) they buy long term investments – 50% of the assets acquired must be illiquid; (ii) they're open-ended; and (iii) they give the safety and reassurance that DC pension schemes need. LTAFs are regulated by the FCA.

Legal and regulatory background

The FCA launched LTAFs in November 2021. Rules and guidance defining the regime can be found in COLL 15 of the FCA Handbook.

Investor interest

LTAFs are attracting interest from:

1. Defined contribution pension scheme investors

• Before inflation struck in recent times, listed equities and bonds hadn't been delivering satisfying returns, yet more than four fifths of UK DC pension fund investments consist of these asset classes due to investment restrictions placed on them. LTAFs could meet a need for investor diversification
• DC schemes need to invest to meet long term obligations, which dovetail with the profile of LTAFs
• LTAFs are regulated by the FCA, meeting pension fund investors' criteria concerning prudent governance and controls

2. Other institutional investors, for many of the reasons given above

3. Sophisticated retail investors, who seek long term investments as a form of risk diversification.

Following lobbying, in Summer 2023, LTAFs were opened up to certain retail investors. This means:

• certified high net worth individuals (those having an annual income in excess of £100 000; or net assets of at least £250 000 excluding home and pension)
• certified and self-certified sophisticated investors eg a director of a company turning over at least £1 million in the last two years
• certain professional clients.

The FCA has imposed some additional threshold protections. Some investors will be able to invest up to 10% of their investable assets subject to meeting a suitability test; being given a risk summary and prescribed risk warnings. Retail investors who are armed with personal advice or a recommendation can invest above the 10% threshold.

Key features

Legal forms

LTAFs are authorised vehicles. They can be structured as:

• an investment company with variable capital (ICVC)

The ICVC is an open-ended collective investment vehicle. The investment monies are pooled and used to buy assets which will generate wealth. The manager must issue shares when monies are invested and redeem shares as requested by shareholders. Every time the shares are redeemed, assets may need to be sold to pay the relevant shareholder for their shares at the prevailing price.

ICVCs can take in retail investors.

• an authorised contractual scheme (ACS)

An ACS can be a co-ownership scheme or limited partnership scheme. It has no separate legal personality.

Investors buy and sell units in the scheme, but investor types are restricted to per se professional investors under MiFID; large investors (investing at least £1 million); or existing investors.

• an authorised unit trust (AUT)

The AUT is structured as a unit trust. The fund manager buys assets with the pooled monies; and unit prices move in line with the value of the underlying assets.

AUTs can take in retail investors.

Setting up

An LTAF manager must be authorised and regulated by the FCA to manage authorised AIFs. If a manager is currently only authorised to manage an unauthorised AIF, and wants to manage LTAFs, it will need to prepare and submit a variation of permission. The more complex the LTAF assets, the more FCA scrutiny of the manager there will be, at authorisation stage.

Another route is to appoint a service provider to manage the fund. This avoids the need to apply for manager authorisation or variation of permission.

Documentation

Requirements for the ICVC instrument; the ACS deed; and the AUT trust are set out in COLL 15.

The LTAF manager needs to draw up a prospectus to include the prescribed information, for example on investment strategy; on how redemptions work; costs; and the key risks of the fund.

The prospectus also needs to include details on the due diligence process; dealing; redemptions and liquidity management plus worked examples.

If the LTAF is being offered to retail clients, there'll be more information to be supplied by way of a Key Information Document to supplement the prospectus.

Governance

Given that the LTAF has been shaped to appeal to DC pension funds, the FCA has endeavoured to set up a regulatory framework which is robust enough to safeguard the monies of pensioners.

The LTAF needs to have a governing body. This must have at least two independent people; or where there are eight or more people, at least 25% of this body needs to be independent. Overall, the members of the body have to have the collective knowledge, skills and experience to understand the manager's activities and the risks it is taking. They need to commit sufficient time to the LTAF; and they need to be honest, to have integrity and to be able to give an independent and objective opinion.

A senior executive at the LTAF manager needs to be responsible for ensuring that it's managed in the best interests of investors.

On monitoring, the LTAF manager must report annually on the management of the LTAF, and specifically on the status regarding: valuation; due diligence; conflicts of interest; and liquidity management.

In picking assets, the manager needs to ensure a prudent spread of risk and this is considered from a whole panoply of angles: market risk, credit risk, liquidity risk and counterparty risk.

Valuing assets

Valuations are key to operating LTAFs efficiently. The Woodford case revealed the murky world of trying to value, or indeed sell illiquid investments in a hurry.

Usually, the manager will act as valuer. However, it will only be able to do this if satisfying certain conditions, i.e. that it can demonstrate the necessary competence and experience to value the types of assets in which the LTAF invests. It falls on the depositary to determine whether the manager is suitable. The alternative and default position is to appoint an external valuer.

The manager must prepare an annual report, which has to be audited. This is meant to shine a light on whether the fund's costs are reasonable. This annual report should be supplemented by quarterly and half-yearly (unaudited) reports.

Permitted investments

The LTAF must invest at least 50% of the value of the scheme property in illiquid, long-term assets. As well as infrastructure etc, this could mean unlisted securities; and listed but illiquid securities.

The fund can invest in both regulated and unregulated collective investment schemes, including limited partnerships and funds of funds.

Liquidity

The LTAF is permitted to borrow, but this is capped at 30% of the net asset value of the LTAF. It is for the manager to ensure that borrowings are closed out if the fund is going to bust that ceiling.

Helpfully, the fund can borrow for many and various reasons: for liquidity; to buy; to borrow (there are no restraints on the aggregate borrowing at portfolio company level).

Lessons were learnt from open-ended property funds, and so the FCA have stated that redemptions can only take place, at their most frequently, once a month. There's no upper ceiling, so a sponsor may take the decision to set permitted fund redemptions annually, if desired.

Investors need to give at least 90 days' notice to redeem their units/shares. Again, that limit could be a lot longer; it's the sponsor's choice.

There are other liquidity management tools that a manager can deploy, as follows:

• limits on the number of units that can be redeemed at one time
• lock-in periods
• fund gates – blocking aggregate redemptions for all investors
• investor gates – these block redemptions for each individual investor; and
• minimum holding periods that investors coming in will have to abide by.

LTAFs will almost certainly be holding liquid assets too – for example, bonds, quoted shares – which they can sell to manage cashflow.

The market's response

Schroders

At the end of March 2023, Schroders Capital was given approval by the FCA for the first LTAF, the Climate+ fund. This was aimed solely at the DC pension funds market. Climate+ has a focus on sustainability. The intention is to invest across four long-term themes: climate mitigation, climate adaption, biodiversity/natural capital and social vulnerabilities.

Investors in Climate+ are subject to a 3-year lock up period, raising the question of whether it is truly an open-ended fund. After this period, a maximum of 5% of the fund's total net asset value can be withdrawn in a quarter.

Schroders Greencoat followed a couple of months later with a renewables-focused LTAF.

Aviva

Again in May 2023, Aviva Investors launched the UK's largest LTAF, valued at £1.5 billion. This consists of direct real estate assets seeded by Aviva Life. Several of the UK's largest property funds had to suspend dealing as a consequence of market volatility characterised by the Brexit and COVID eras. The illiquidity of long term asset funds and restraints on redemptions seem to be an ideal resolution to this issue.

From an ESG perspective, Aviva says it will regularly review the carbon emissions of buildings across the portfolio. It will also conduct social value audits, determining the social needs of the immediate surroundings of the buildings.

BlackRock

In the same month, BlackRock became the latest financial institution to receive regulatory approval from the FCA to launch their long term asset fund. The fund, named Diversified Alternative Strategies LTAF, will have allocations in various asset classes including: private markets, real assets, private equity, private debt and listed markets investments.

In launching this fund, BlackRock stated a desire to further support its DC pension fund clients. This stems from an increased demand from these clients for access to private markets and a diversified exposure to a range of asset classes.

Waystone and Fulcrum Asset Management

The FCA has approved the launch of Waystone and Fulcrum Asset Management's LTAF. This will focus on a blend of asset classes – infrastructure, private equity, private credit, real estate – for a single DC scheme.

Willis Towers Watson

WTW has announced its intention to launch a private equity-focused LTAF which is awaiting FCA approval. The fund has already received up to £450 million in initial commitments ahead of its launch.

The future

It is worth noting that the fund structure failed to attract applications from asset managers until recently, evidenced by the 16-month gap between regulatory approval and the Schroders approval for its prime mover fund. Does this mean that the LTAF is doomed to failure? We think not. There is often slow take-up of a new possibility and managers and the regulator need to find their feet and let the approval process run its course.

LTAFs could be a valuable way to boost the UK economy: they exist to unlock a large pool of capital tied up in pension funds in a regulated manner with a view to funding the UK's infrastructure needs while producing long term stable returns for investors. They will help the UK compete globally, by driving more capital into unlisted UK companies and infrastructure. There is a strong market need for them and many players are taking a keen interest.

To find out more about LTAFs, please contact our leading Investment Funds and Regulatory teams.

Authors: Bradley Rice, Partner; Cheng Bray, Senior Expertise Lawyer; Brakemi Ebi-Ogbomah, Trainee