Travers Smith's Alternative Insights: "Retailisation" of private capital

A regular briefing for the alternative asset management industry.

Last month, the UK government promised that, within a year, it will introduce a new investment fund regime that will make it easier for pension funds – and potentially other investors – to access longer-term, illiquid investments. That could be excellent news for alternative asset managers who have been looking hard at ways to widen their investor base. It is also good news for the growing pools of "retail" capital that would like to access the more diversified – and frequently high-performing – funds that have previously been the preserve of institutional investors. Of course, regulators will need to make sure that sufficient safeguards are baked-in to the proposals: it is important, for example, that investors do not have an expectation of short-term liquidity that the manager cannot guarantee – and some high-profile fund failures have put that concern centre-stage. But these and other mis-selling concerns can be dealt with. Indeed, the Investment Association's initial proposal, which seems likely to be the basis for the UK Long-Term Asset Fund, already included a number of important safeguards.

A UK regime will have limited value, of course, for alternative asset managers that want to access retail investors based in the EU. They may be heartened that the European Commission has launched a review of the European Long-Term Investment Fund (ELTIF), a vehicle launched in 2015, but which has not been widely used. The marketing passport offered by the ELTIF is attractive, but only if some of its more restrictive features are relaxed, including strict portfolio composition requirements. Changes to the rules could also come through next year, and the alternatives industry is already feeding into the emerging reform proposals.

But retailisation is already happening in Europe, and managers do not need to wait for these speculative UK and EU rule changes. This week, we published a paper examining the main routes to the retail market that private capital firms are using now, and the opportunities and challenges associated with each. Mindful of the pitfalls, we cautioned that careful planning is required before a firm embarks on a project to widen its investor base, because the regulatory compliance costs can be significant and each of the available vehicles and regimes has costs and benefits.

it is important...that investors do not have an expectation of short-term liquidity that the manager cannot guarantee

Within Europe, it is hard to structure around the requirement for a "Key Information Document" (KID) – a pro-forma information sheet that has to be prepared for a product that is sold to any retail investors who cannot be "opted up" to professional status. This is not an attractive requirement, principally because it requires simulated performance scenarios and managers worry that it can be misleading for investors. However, the liability regime means that, with suitable caveats, many alternative asset managers have got comfortable that they can issue a KID, even if those in the UK hope that regulators will modify the requirement in a post-Brexit world. Some managers have managed to shift responsibility for the KID to a wealth manager, which is possible to a significant extent, but there is likely to be some residual liability that is hard to avoid.

Of course, closed-ended funds, including listed vehicles that offer investors liquidity through a secondary market in the fund's shares, are an option but these can be expensive to launch and operate and may trade at a discount to net asset value. So-called "alternative UCITS" – where the fund is structured as a regulated open-ended retail fund – are another candidate. Here the liquidity mismatch issue does need to be properly addressed, but innovative solutions can be crafted to give investors, and regulators, comfort.

Access to private equity by company-sponsored employee retirement plans in the US will see a significant widening of private equity's investor base, and there is strong and growing demand among individual savers in Europe. There are many challenges for the industry in navigating the needs and expectations of these investors, especially in an industry that is much more familiar with an institutional and sophisticated market. But as private capital markets have matured, they have grown increasingly accustomed to burdensome regulation, demands for transparency and even greater liquidity. There is no doubt that more retail investment is coming – and many alternative asset managers are more than ready for it.

To read our detailed paper on retailisation of the asset class, click here. If you would like advice on your options for accessing the retail market, please contact us.