Movement of private markets investing into the mainstream of the funds industry is driving demand for products to deliver private market exposure with a measure of liquidity – and ‘semi-liquid’ funds continue to rise in prevalence as a result. Defined as structures with hybrid asset mix of public and private assets in an open-ended fund vehicle, they could, over time, provide a more common route for retail investors to invest in private assets (AKA ‘democratizing’ private markets).
But while semi-liquid funds are having a moment in the spotlight – due in part to them being seen as a solution for channeling capital towards long-term investments in the real economy, including towards those that promote, objective of smart, sustainable, and inclusive growth – they are not new concepts. Also known as ‘evergreen’ funds, they have long been part of the funds industry toolkit for specialist private capital managers.
European fund frameworks
However, the entry of established private market fund operators into the semi-liquid space at the scale expected is new and distinctive. In this context, the key frameworks emerging are the UK’s Long-Term Asset Fund (LTAF) and the EU’s European Long Term Investment Fund (ELTIF). Both have been recently updated to broaden their appeal.
The LTAF was launched in 2021 but rules widening its availability took effect last year. ELTIF 2.0, enacted in January, is a second attempt to define a widely used semi-liquid fund model, opening up wider opportunities for managers to provide private markets access for professional and retail investors. ELTIFs are now more accessible, with streamlined distribution and a pan-European passporting label.
So, while these frameworks are in place, managers face the challenges of implementing product ideas using vehicles and processes that in some areas have been tested only at limited scale.
Deploying capital
Semi-liquids are open-ended funds making significant in private assets but allowing for greater investor liquidity than traditional private asset funds through periodic redemption requirements – albeit still with restrictions. The LTAF requires a minimum 90-day notice period with monthly underlying asset valuations. FCA guidance indicates that 50% of assets be unlisted; ELTIF requirements are similar.
The coming generation of funds will likely use a greater proportion of fund-of-funds-type structures or funds with access vehicles to gain exposure to private equity, debt, infrastructure, and real estate strategies, allowing more rapid deployment of capital and diversification from the outset.
Liquidity considerations
Semi-liquid fund structures are a tool for investors to “bridge the gap” between daily trading and closed end funds, as they address the liquidity mismatch issue. Some operate as an open-ended fund with limited investor redemption cycles. This will differ across the varying jurisdictions and regulations underpinning a particular fund structure.
Crucially, there is the question of what is meant by ‘semi-liquid’ in terms of allowing investors’ access to their holdings. How do managers align this requirement for some liquidity with the nature of their underlying assets, which could include very long-term illiquid assets such as infrastructure?
Semi-liquid funds (especially in the regulated fund space) may have built-in mechanisms to protect investors’ interests, such as independent valuation of assets, robust governance structures and transparency in reporting. Investor education is also key when managers are marketing the fund – which although open-ended will not operate exactly like a daily trading mutual fund.
Other liquidity management tools as part of the solution include lock-in periods for initial investments, minimum holding periods for investors, side-pocketing or deferred redemptions. Market entrants will require the ability to apply these tools across different fund structures and in line with specifically defined risk limits, investor, and regulatory requirements.
Investor servicing
Traditionally, managers of private capital funds operate high-value, low-volume operations with small numbers of investors investing large amounts. ‘Democratizing’ private markets would turn this on its head, with larger numbers of investors committing smaller investments.
Managers will require the capacity to both provide valuation updates for these investors on a regular basis and to offer mechanisms for redemption on terms that may be more complex and nuanced than they may have previously managed. As their investor base grows, they will require the operational flexibility and capacity to support this growth, and to ensure compliance with applicable regulations for offering complex private market investments to professional and retail investors.
Solutions to these and further challenges will also vary depending on a fund’s objective, investor profile and investment approach. Coming months will see the structures and policies of these products further tested as they become further established – and managers’ product ideas progress from theory to practice at greater scale.
Clive Bellows is Global Head of Private Capital Administration and President, EMEA at Northern Trust
