Let’s start with what a Long Term Asset Fund is. These are a new UK fund structure for illiquid assets. Investors may be wondering why the funds industry and indeed the UK regulator are nudging forward these vehicles for retail distribution in the UK after we have already seen the problems created by daily-traded property funds.
In essence, fund managers are looking for a fund they can place illiquid assets in which can also be sold to retail investors. But even the Long-Term Asset Fund cannot get away from the liquidity mismatches which inevitably arise. You cannot flip an office block in a week, so how can you park that asset in a fund and expect it to meet daily liquidity needs? Right now, under the UK’s Long-Term Asset Fund regime, fund managers can delay your exit from an LTAF or indeed borrow to meet redemptions. Many industry commentators feel that widening LTAF distribution before the product has been proven, and proper standards imposed, is inviting trouble.
Richard Stone, Chief Executive of the Association of Investment Companies (AIC), said: “We believe selling Long-Term Asset Funds to retail investors is an accident waiting to happen. As the experience of daily-traded property funds shows, the industry has a poor record of safely making illiquid assets available to consumers within open-ended funds. LTAFs are likely to repeat these failings, as minimum notice periods will not prevent liquidity mismatches which will be particularly harmful to retail investors.”
A year since the rules for Long-Term Asset Funds were introduced, no product has been launched. “Limiting purchases to 10% of an individual’s savings will not prevent serious losses if things go wrong,” Stone explained. “With a high risk of investor harm, no changes should be made to the distribution of the LTAF at this time.”
Stone thinks providers should focus on developing Long Term Asset Funds which appeal to informed investors, creating a strong foundation for the LTAF’s long-term success. Taking the time to get LTAFs right will benefit both providers and investors and maintain trust in the investment industry.
“Once products have been tested through different market conditions, with proven safeguards in place, widening retail distribution of LTAFs could be considered with greater confidence,” he said.
The AIC’s response follows the IMF’s warning last week about the systemic risk posed by daily-dealing open-ended funds that invest in illiquid assets.
Two-tier Long Term Asset Fund regime proposed
Given the foreseeable risks to consumers, the AIC says it believes no changes should be made to the distribution of LTAFs at this time. The FCA should review this position after LTAFs have become established and have demonstrated how they operate in good and poor markets. Such a review would consider if LTAF operators have been able to set sufficient notice periods to prevent liquidity mismatches and how they have used liquidity management tools.
Before allowing Long-Term Asset Funds to be marketed to a wider retail market, the AIC proposes that the FCA should introduce a two-tier LTAF regime.
One tier of LTAFs would follow the current rulebook and would not be distributed to a wider retail market. The other tier of LTAFs would incorporate additional consumer protections to make them more suitable for wider retail distribution. Only when these measures have been introduced, and the FCA has reviewed market experience, should the LTAF be considered for distribution to a wider retail market.