I want to launch a Long Term Asset Fund: what are the next steps?
The LTAF will therefore enable certain types of retail investors to access less liquid asset classes such as infrastructure, real estate, private equity and private credit through a vehicle operating in a robust governance framework. As the LTAF is open-ended, investors will be able to regularly redeem at a price reflecting the value of the assets held by the fund.
This note details the next steps for managers interested in launching an LTAF now that the FCA has published its final rules.
Questions to consider
The LTAF’s key design features will be determined by investor demand. At the outset managers should consider which investors they intend to target with the product.
Professional investors, and in particular UK DC pension schemes, are the primary investor base contemplated by policymakers. DC trustees will likely have particular sensitivity around liquidity and the level of management fees (especially in light of the DC charge cap with which DC trustees of default pensions schemes must comply). Pension consultants will be able to help managers understand the features which are most important to trustees of DC schemes, and will be the key to unlocking the UK DC market.
Sophisticated and high net worth investors can also invest in the LTAF. If these types of investors are the target then managers will need to build relationships with wealth managers. For this target market it is likely that the LTAF will be launched for a specific wealth manager to distribute to its client base.
The FCA is also considering whether to open access to the LTAF to a broader range of retail investors in 2022. This would likely include clients of wealth managers and financial advisers who don’t meet the required level of net worth and sophistication to be eligible to invest in the LTAF at the outset.
Having determined the universe of target investors, managers will need to design an investment strategy and prepare an intended “model portfolio”. The LTAF rules are very flexible so most strategies should be compatible. The LTAF can be established as a fund of funds and therefore it may work well for managers to use the LTAF as a “feeder” into a diversified mix of private funds it already manages.
The LTAF rules demand a high level of transparency for investors. Managers will need to clearly state the fund’s objectives and strategy, and how the type of investments that the LTAF will make can help achieve those goals, including the use of any benchmarks by which to measure performance.
Given the long term nature of the LTAF’s investments, it is anticipated that LTAF managers may well incorporate ESG considerations into the investment process. This may be particularly appealing to the UK DC market.
The LTAF has very flexible investment rules that permit investment in a range of liquid and illiquid assets, such as private equity, private debt, and infrastructure, and to invest in other funds. Crucially, the LTAF’s dealing and redemption terms should align with the liquidity of the underlying assets, with redemption opportunities for investors that are no more frequent than monthly, and with a minimum 90-day notice period. Redemption terms will need to match the target investors' expectations and must also be acceptable to the regulator. The FCA is likely to be very focused on understanding managers' liquidity management policies in order to be comfortable that redemption obligations to investors can be met.
Related to this, managers should consider the life of the fund. For instance, how will its mix of investments change over time, and will this materially change the liquidity of the fund? How and when will the investments come to maturity?
The LTAF is able to use the full range of liquidity risk management tools, such as gating and limited redemption. Managers will need to identify the relevant tools in advance and clearly disclose to investors how they might be used.
The LTAF’s fee structure is important for two reasons.
First, the LTAF's authorised fund manager (AFM) will be required to undertake an annual value assessment, in common with other FCA regulated funds. The AFM will be required to assess and demonstrate that the LTAF offers value to its investors relative to the fees charged. Indeed, the LTAF’s AFM must undertake a more extensive annual assessment than that required for other UK regulated funds by also considering valuation of the assets, liquidity, conflicts of interest, and due diligence, and how they have been performed in the interests of the LTAF and its investors.
Second, managers will need to consider whether the proposed fee structure works within the confines of the regulations and, operationally, for distributors. If selling to DC pension schemes, managers will need to consider the DC charge cap. While the LTAF's management fee might exceed the charge cap of 75bps, trustees of UK DC default pensions schemes will need to ensure that on average the charges across the portfolio of investments do not exceed the cap. Moreover, the government is considering how to accommodate performance fees within the charge cap.
Ultimately, managers will need to ensure that their proposed fee structure is compliant, practical and within the range that distributors can work with.
As previously noted, an LTAF’s AFM must undertake an annual assessment of its valuation of the LTAF’s assets. The rules also prescribe a quarterly reporting requirement. Consequently, the AFM will need to ensure that it is able to robustly value the assets or to rely on third-party valuations. Regardless, the responsibility lies with the AFM.
Whether the manager has the relevant expertise will depend on the type of assets that it intends to invest in. The LTAF’s depositary will need to validate that the AFM has the relevant skills, expertise, and experience to perform an in-house valuation. Otherwise, the AFM will need to procure an external valuer.
Managers may perform the AFM function themselves (provided they have the required Part IV permissions to do so) or bring in a third-party AFM. Managers will need to consider whether they have the relevant skills to perform the role themselves, noting the specific demands that are placed on the LTAF’s AFM, not least the annual assessments that were previously mentioned. Managers not used to working within the parameters of the FCA’s authorised fund regime might find it beneficial to rely on a third-party AFM that has the relevant expertise and prior experience with these assessments and other obligations. It is important to select an AFM that understands the LTAF’s intended asset class.
Managers will also need to select a depositary with an in depth understanding of the relevant asset class. Again, as previously mentioned, the LTAF’s depositary will need to accommodate the specific demands that the LTAF rules place on the AFM and on service providers.
In theory, FCA applications can be submitted from 15 November 2021. However the FCA is encouraging managers to engage with the FCA in advance of submitting an application.
In practice we anticipate a minimum six month lead in time to launch as the steps will be:
- identify service providers and agree commercial terms;
- engage with distributors to settle on the target market and required LTAF features;
- model the portfolio and liquidity management policy;
- model management/performance fees;
- prepare FCA application pack; and
- await FCA approval (expected to be two months).