While there is still demand for private equity, many investment strategies are moving toward private credit, infrastructure, and real estate. Several funds are now using a mixed approach, pivoting from a vintage to evergreen strategy. Most of the Part II funds that will be launched in 2023 are primarily open-ended, due in part to the increased desire among asset managers to bring in retail investors. A host of upgrades to the European Long-Term Investment Fund (ELTIF) framework, voted on 15 February by the European Parliament, should help to lighten some of the burdens on such funds while ensuring protections for retail investors.
Several obstacles have prevented Part II funds from reaching retail investors. While they are very open in terms of strategy and eligible assets – which has not been the case for ELTIFs –, Part II funds have been confronted with the issue of the distribution path. As AIFs, they benefit from the AIMFD passport, but they are restricted to professional investors. If you want to market such funds to retail investors, you have to do it on a country-by-country basis. Also, Part II funds are less flexible in terms of structuring, which can be a sticky point when promoting them. ELTIFs too have not proved to hugely draw retail investors, mainly due to eligible asset restrictions and investor restrictions such as a high entry ticket and suitability assessments.
ELTIF 2.0, as indicated, should make it easier for such funds to capture the retail market. For one, an ELTIF will be able to more easily invest in private equity, private credit, and real assets, which previously required going through eligibility tests which were often somewhat complicated. Also, minimum entry tickets will be abolished. However, structuring an evergreen fund means dealing with redemption requests from investors, which can be tricky when you have an illiquid asset class. Therefore, you need to be more operationally prepared and have the right tools in place.
We’re seeing more open-ended structures, which are better suited to catch the retail market.
Liquidity measures, redemptions, and transfers
Allowing investors to redeem from a fund that has invested in illiquid types of assets requires liquidity measures. Finding the right balance is key, which is why we are seeing a move toward uniformity, such as with AIMFD II. For ELTIFs, what we often see is the use of the liquid pocket. The ELTIF has to invest majoritively in long-term, ELTIF-eligible assets, but it can also invest up to a certain percentage in UCITS-like assets which are very liquid.
Some liquidity management tools include long redemption cycles, notices, and settlement periods, as well as smaller redemption gates. Restrictive as they are, these tools are imperative when you are looking at an open-ended structure and illiquid assets. Another tool, one that is part of ELTIF 2.0, is a matching system in which you pool exit requests with new subscriptions.
Should an investor wish to exit from an ELTIF, they have the possibility of transferring their shares to another investor, a practice that has always been permitted. One obstacle, however, is the lack of platforms to facilitate such transfers. This lack could certainly spawn a new niche market and spur competition, a potential advantage to retail buyers who could then benefit from discounts in the secondary market. Also, under ELTIF 2.0, we are now seeing the possibility of entering into credit facilities for the purpose of providing liquidity, which previously was not allowed.
From the view of the fund formation, 2023 seems to be a very promising year.
A broad look at 2023
We expect that 2023 will see a huge number of the open-ended, evergreen variety. Much due to regulatory upgrades, we will likely see growing interest in ELTIFs. There will still be opportunities for Part II funds in the future which do not have the ELTIF label on top, particularly when it comes to third-country funds and whenever you would like to be fully openended and in the liquid sphere. Part II funds would be the only solution in this case.
Some of the expected changes to ELTIFs
Wider scope of eligible assets
ELTIF 2.0 will greatly broaden the scope of eligible assets, and it contains a simplified definition of real assets.
Portfolio composition and diversification
The updated framework alters portfolio composition by reducing the ELTIF’s pocket for investments in long-term, illiquid assets.
Suitability assessment
The suitability of retail investors will be assessed, and documents will be provided that clearly explain a fund’s redemption rules.
Harmonised distribution regime for retail investors
ELTIF 2.0 harmonises the distribution regime and removes the former entry ticket, giving retail investors easier access.
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