The goal of the European Long-Term Investment Fund to provide much-needed funding for small and mid-cap private companies has yet to be met – but a redesign could change that, say Holly Gardner and Adrian Whelan of Brown Brothers Harriman.
The European Long-Term Investment Fund (Eltif) has been discussed at length within the industry since its inception in 2015. Unfortunately, much of the discussion has focused on why the Eltif hasn’t been the policy success of Ucits or AIFMD, for example. The explanation for the tepid growth of Eltifs lies in both the product supply and investor demand sides.
Regarding product supply, conventional wisdom suggests that the portfolio composition rules are too restrictive and inflexible to be attractive. Likewise, on the demand side, investor appetite has been dampened by overly complicated point-of-sale and investor eligibility requirements.
The result of this dual-sided dynamic is that Eltifs haven’t flourished as anticipated.
The Eltif, in theory, is the middle ground between very liquid Ucits funds and often illiquid AIFMD funds. The Eltif policy goal was explicitly framed to allow for a wider range of investors to benefit and to provide much-needed funding for small and mid-cap private companies across the continent through the channel of highly regulated, less liquid investment funds. That policy goal has not yet been met, but times change.
The time is now
To date, Eltif success has proven elusive; however, both current market dynamics and targeted regulatory changes mean that for the Eltif 2.0, the time is now.
Globally, there is pent-up investor demand to access higher-yielding asset classes such as private markets and illiquid assets. This demand is coming from both the mass affluent and retail channels, according to data provider Preqin. In the US, interval funds and business development companies are flourishing, and one of the UK’s most enthusiastic post-Brexit policy ambitions is the delivery of the Long-Term Asset Fund, which matches illiquid investments to UK pension scheme investors.
“Globally, there is pent-up investor demand to access higher-yielding asset classes such as private markets and illiquid assets. This is coming from both the mass affluent and retail channels.”
The European manifestation of this phenomenon is the Eltif 2.0, and very targeted revisions have been made to make the structure more attractive.
Having been approved by the EU parliament committee on January 12, 2023, the Eltif is making its way through the final approval process. The revisions include the following:
• a much broader universe of eligible assets and investments
• the ability for an Eltif to co-invest with other funds and managers
• much more relaxed portfolio composition and diversification requirements
• more liberal borrowing rules
• more advantageous redemption rules, and
• major upgrades to the marketing and distribution rules to make selling Eltifs easier to a wider range of investors.
All in all, it is expected that the new rules set the Eltif up structurally for future success, which to date has proven elusive.
Beyond the Eltif rulebook
With a now fit-for-purpose structure in place, many are beginning to focus on what else is required to deliver a successful Eltif to the market. We see three key ingredients to the success.
1. Getting the basics right.
Regardless of an improved Eltif structure, if managers want to bolster investor and regulator confidence, things need to run smoothly. Production of timely and accurate NAV [net asset value] publication, investor contract notes and monthly statements are a good start. There’s a lot to do behind the scenes to make an Eltif work, but investors needn’t be exposed to all the details unnecessarily. Marrying the operating models of the liquid and illiquid worlds requires flexibility and expertise in management, fund administration and transfer agency.
Can the administrator reliably price a mixed portfolio of assets (alternatives – because that’s what investors came for, and liquid securities – because that’s how managers maintain sufficient liquidity)? How does the fund manage capital commitments? Through the use of a traditional Ucits-like transfer agency system or through a higher-than-usual-volume in an alternatives one?
These are all very real challenges for the manager and administrator to solve, but not ones that investors will necessarily focus on.
2. Distribution dream.
The goal is to sell a hybrid fund through the existing superhighway distribution channels already well established for Ucits. However, to date, sales have been constrained to high-net-worth investors, and even then, getting the operating model right on flexible subscription and redemption cycles has been challenging. In order for Eltif 2.0 to really take off, distributors need to understand the product and be able to instruct deals and accept reporting from the administrator through established channels. Likewise, managers should be aware of how certain liquidity tools like redemption gating can impact straight-through processing at their distributor shops, which suggests that these tools should be used judiciously.
3. Two worlds collide.
When dealing with a mixture of traditional and alternative fund structures, it is critical to have an operating model that can manage the nuance of each. For example, Eltifs often require foreign-exchange hedging at portfolio and investor levels, which is not particularly common in the pure alternatives space but is business as usual for any Ucits servicing team. Anything visible to investors should be treated with the utmost sensitivity and accuracy. Operational errors that might not be particularly alarming in the Ucits context may confirm suspicions – albeit unfairly – of hybrid products, slowing take-up.
Getting these ingredients right, in concert with current market dynamics and targeted regulatory changes, could see the Eltif 2.0 going beyond its stated aims.
Holly Gardner and Adrian Whelan are senior vice presidents at BBH in Luxembourg.
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