Diversification is one important benefit of having access to semi-liquid strategies for defined contribution pension schemes, wealth clients, and retail investors. Having access to a wide range of illiquid investment strategies, such as private equity, private debt, infrastructure or venture capital offers diversification benefits in an era of significant performance concentration in equity markets. For example, the Magnificent Seven stocks accounted for the majority of gains in the S&P 500 in the 2023-2024 bull market.

Private Assets and Investor Returns

Additionally, private assets have historically provided very high returns, which are now available to more investors through LTAFs.

Another benefit of LTAFs is that investors will now be able to invest in a wide range of local private UK businesses across different sectors, such as infrastructure, real estate, renewable energy, biotechnology, or artificial intelligence.

However, given the opaque and complex nature of the illiquid assets held by LTAFs investors have to be careful when conducting their due diligence. Below we have summarized a number of factors that should be assessed by investors and their advisors.

Understanding LTAF Terms and Liquidity

An LTAF must invest at least 50% of its assets in unlisted securities and other long-term assets, while another part of fund has to be invested in liquid assets. These liquid assets are actively traded and can be sold to generate liquidity for the fund and facilitate redemption payments. LTAFs are open-ended, are also able to utilize fund-of-funds strategies, and are subject to a notice period for redemptions of at least 90 days (and no more frequently than once a month).

It is important for investors to carefully review the liquidity management tools of the fund, such as the initial lock-up periods stopping investors from redeeming, and limits on the number of units than can be redeemed over a certain time periods.

The fund manager of the LTAF can also suspend redemptions, meaning that investors do not have access their money. After discussing the composition of the liquid and the illiquid part of the strategy, investors should have confidence that the LTAF can meet redemptions and that there is no mismatch between the liquidity terms of the LTAF and that of the underlying investments.

It is useful if the LTAF manager can provide a historical analysis of cash generated each quarter from exiting illiquid investments. This can reassure that the illiquid portion of the LTAF strategy will generate liquidity in line with investors’ expectations; this is of course only possible if the LTAF manager has a long track record in managing private and illiquid assets.

What’s a Realistic Investment Return?

Access to potentially high returns is one of the main attractions of LTAFs for investors. However, they have to keep in mind that LTAFs are forced to hold liquid assets including cash and returns are therefore diluted, meaning that they will only partially capture the potential attractive upside of illiquid assets through the LTAF.

It is important for investors to understand the composition of the illiquid portion of an LTAF to set their return expectations as different underlying types of illiquid investments have different risk/ return characteristics and a different expected duration.

For example, private equity typically has an investment horizon of 10 years or even longer, and generally offers a higher risk/return profile compared to private credit, which usually has a horizon of over five years (but can be shorter as well).

Infrastructure assets offer lower returns and lower volatility as they generate stable cash flow from contracts. On the other end of the risk/return spectrum, venture capital invests in more speculative early-stage small companies that have the potential to generate outsized returns, but with a higher loss ratio and volatility as well.

Understanding LTAF Total Fee Structure

Investors have to assess the total fees they are paying through an LTAF. Besides the management fee they are paying directly to the LTAF manager, they could be indirectly also paying fees to the underlying fund investments of the LTAF, for example in case the LTAF manager is allocating to third party funds. These funds also charge a management fee and could also charge carried interest, the share of profits from investments made by the fund that the managers receive, similar to performance fee.

If the underlying funds charge low fees and there is no performance fee, the investors of an LTAF benefit from higher net returns. However, in the opposite scenario investors of an LTAF are likely to end up with much low net returns over the long-term.

How to Value LTAFs

The valuation of the liquid part of an LTAF is straightforward as market prices are available for exchange-traded public instruments. However, the situation is different when we look at private assets as these are not traded and there are no publicly available data.

Having independent third parties involved in the valuations process is considered to be best practice by the FCA. It is vital for investors to be confident with the valuation process of the LTAF manager. Often LTAF managers use their own valuation committees. Investors have to ensure that processes followed are robust, and the valuation committees are independent from investment teams and act in the best interest of investors following transparent and consistent valuation guidelines.

Transparency Is Important to LTAF Investors

As with any other investments, transparency is of high importance to investors. Given the complex nature of LTAFs, investors should be comfortable with the amount of information they receive on the investment team, the process, the portfolio holdings and the performance of the fund.

Fund Manager Skill and Experience Matters

LTAFs are complex funds designed to invest efficiently in long-term, illiquid assets while also offering some liquidity to investors. An asset manager needs to have significant scale and resources available to reassure investors.

A large investment team with significant experience and track record in allocating to private assets, and a wide range of skillsets based on the different asset types included in the fund, is paramount. In the case of a fund-of-funds structure it is important for the investment team to have gained significant experience in fund allocation and due diligence, for example with prior experience at a fund of funds or in the investment consultant area.

Besides the investment resources a team should include adequate resources on the risk, operational, legal and valuation side to manage a complex strategy such as an LTAF with an institutional-level quality. Clearly, it would be very difficult for a small boutique asset manager to meet all the requirements needed to manage an LTAF.

Why Should Investors Chose LTAFs?

LTAFs can provide diversification benefits and access to higher returns to wealth clients and retail investors. However given their complex and risky nature there are a number of factors that investors have to carefully assess before making a decision to invest. Education is key and advisors can play a major role in assisting private wealth clients and retail investors in their due diligence process.

Investing in Private Markets Explained

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.