In early 2024, updated regulation will help open up PE funds to retail investors. James Abram, senior consultant, Temenos Multifonds, explores the challenges and opportunities this change presents to PE and traditional managers.
From early 2024, updated European Long-Term Investment Funds (ELTIF) regulation will apply and will help extend private equity (PE) funds to retail investors. The original ELTIF regulation had limited success in making long-term investments accessible to a broader audience. ELTIF 2.0, however, will be a catalyst for change.
It could create new revenue streams for private managers, add alternative investments to the funds offered by traditional managers, and give retail investors access to high-performing investments. But “retailisation” is a big shift, especially for private managers accustomed to high-value, low-volume business.
In January 2024, ELTIF 2.0 will replace the EU’s original ELTIF regulation, which was designed to make it easier for retail investors to participate in long-term investments such as private equity. Removing some of ELTIF’s restrictions, it could be a catalyst for growth which offers opportunities for investors, private managers and traditional managers alike.
What’s driving the retailisation trend?
Demand for “democratised” access to PE funds is coming from two areas. First, from retail investors and their drive for alpha. Increasingly sophisticated, they’re aware that returns from the top PE funds significantly surpass potential gains in the mutual fund market. This is frustrating for them, as they are currently offered funds that are a mix of fixed income and listed equities, neither of which have performed well in recent years.
Many retail investors have also developed a taste for private investing through increasingly well-organised crowdfunding platforms, which give them direct access to potentially high-growth companies that offer attractive returns.
The second driver for retailisation is the funds themselves. Private funds have had great success selling to institutional investors, but their market has become saturated. For them, a brand-new pool of investors could offer an attractive extra revenue stream as opportunities dry up in their usual client base.
So, if the demand is there from both sides of the market, what’s standing in the way?
Three challenges to PE retailisation
The first problem is how to deal with the change in scale and volume. Typically, PE managers operate high-value, low-volume operations, offering a tailored service to a small number of investors who may individually be putting in hundreds of millions of euros. Retailisation turns this on its head. Tens of investors become thousands, while individual investments could be as low as €1,000. Yet managers still need to be able to provide PE features such as commitment tracking and capital calls at this vastly different scale.
Compliance is the next challenge: specifically, how to stay compliant while offering PE investments to both professional and retail investors. The original ELTIF regulations were prohibitive, allowing funds only to be marketed to particular investors, restricting the private assets available for investment, and demanding a €10,000 minimum investment. While ELTIF 2.0 loosens many of these restrictions, managers will have to comply with MiFID II appropriateness tests as they onboard investors.
Finally, how will managers deal with the liquidity requirements of funds under ELTIF 2.0? While professional PE investors typically don’t need to take money out of their investment before its term ends, retail investors may need to. Managers will therefore need to put funds aside to cover this, as in many cases, the liquidity required won’t match up with long-term underlying assets such as property.
PE retailisation has the potential to change the shape of the market. Bringing in potentially millions of retail investors will create a big inflow of money into the asset class and offer finance and investment to small-to-medium enterprises that don’t normally have access to markets. Traditional private managers are not geared up for retailisation. The leading PE fund management system, for example, has limitations on the number of investors it can serve. And spreadsheet-based solutions are not adequate to handle the volumes and the depth of administration involved. To take advantage of the opportunities that ELTIF 2.0 opens up, private and traditional managers need systems that can support PE and alternatives at high volumes and with rapid scaling, including five key components: • Automation. To manage high volumes, systems that use straight-through processes can ensure transactions that meet fund requirements are processed automatically. • MiFID II and KYC/AML frameworks. These need to be built in to allow for appropriateness assessments and onboarding of high volumes of investors. • Support for closed-ended fund structures. Systems should offer commitment tracking, capital calls, drawdowns and distribution processing and support sales on a secondary market. • Embedded liquidity management. Whilst ELTIFs will be closed-ended structures, the regulation calls for ‘redemptions during the lifecycle’. This should include unitisation, the ability to define lock-up periods, apply gating controls and support side pocket creation. © 2023 funds europe
The essential components of an ELTIF 2.0-ready system
