With the net zero transition requiring vast sums of capital, governments and fund managers are becoming inventive to increase allocations to long-term assets.
The need for long-term capital to finance projects and technologies to manage the low-carbon transition is well understood. Governments and the finance sector are responding with new policies, fund regimes and products.
The UK government, for example, is looking to changes to Solvency II that bodies like the Association of British Insurers say will allow the industry to play a greater role in the transition to net zero. This month, the UK’s Pensions and Lifetimes Savings Association (PLSA) called for further reforms as part of the government’s plans. Joe Dabrowski, Policy Officer at the PLSA, says this includes reforms to Solvency II for insurers to incentivise them to directly take over more illiquid assets held by pension funds as they approach buy-out.
PLSA was also involved in the design of the Long-Term Asset Fund (LTAF), a fund regime that launched in the UK this year.
LTAF evolution
In May of this year, Schroders launched the first LTAF. Duncan Hale, Private Markets Group at specialist asset manager Schroders Greencoat, sat on the Bank of England’s Productive Finance Working Group, which designed the LTAF. Hale says much of the group’s time was spent on the LTAF, and it was aimed to not only allow investors an operationally robust way to access illiquid assets, but also to help encourage interest in illiquid assets by thinking about ways that they could demonstrate they could provide value for money.
David Seex, Head of Private Asset Solutions and Co-Head of Private Asset Sales at Schroders Capital, says the firm’s Climate+ LTAF provides a vehicle for private multi-asset investment for the defined contribution (DC) pension market. The LTAF structure allows for unit-linked insurance products to invest in a full range of productive finance assets like forestry, renewable energy infrastructure and growth companies. “Delivering this thematic through a diverse set of private asset classes in a suitable structure has been a significant challenge,” says Seex.
Hale adds that fund regimes such as LTAFs are important given the scale of investment needed for the energy transition, but also investor requirements for strong risk-adjusted returns at an appropriate risk level, adding that assets such as renewable energy can give investors a “basket of risk” with an illiquid product.
Like Hale, Mark Meiklejon, Head of Real Assets Investment Specialists at Aviva, sat on the Productive Finance Working Group that led to the development of LTAF.
“In the past 25 years or so that I’ve been doing this, it is genuinely the first time that regulators came together with policymakers and the asset management community to make something different and make it happen.”
Prior to this, he says, illiquid funds were seen as the “devil incarnate” particularly for retail or wealth clients. With the LTAF, he says, it marks a willingness and conviction to make it work.
Aviva’s decision to launch an LTAF, focused on real estate, coincided with its decision that daily trading for illiquid or real asset funds was no longer appropriate and prompted the closure of such funds. The LTAF fund regime offers an appropriate level of liquidity, says Meiklejon.
“It is an appropriate mechanism to offer broader access to a range of investors to these very long-term asset classes, but without forcing managers to hold too much cash or represent too much risk.
“It provides that sensible compromise to offer enough liquidity for most investors, typically quarterly, but also offers enough protection for other investors that don’t need as much liquidity by not forcing asset sales at the wrong time.”
Looking at the bigger picture, Meiklejon notes that the arrival of LTAF comes as UK defined benefit (DB) pension plans wind down and look to sell their illiquid holdings, and UK defined contribution (DC) plans grow in size.
“DC pension schemes can use some of those illiquid assets as portfolio building with a structure that offers enough liquidity,” he says.
According to Meiklejon, Aviva is potentially looking to convert an existing long-term diversified real assets fund to an LTAF.
“You’re going to see significantly more vehicles be launched in the market. But they’ll predominantly be focused on the DC investors and that will include sustainable infrastructure and transition real estate assets.”
ELTIFs reform
The moves in the UK come as Europe seeks to improve its long-term fund regime – European Long-Term Investment Fund (ELTIFs).
ELTIFs launched in 2015 as a pan-European regime for alternative investment funds that would channel capital or long-term investments into the real economy. The EU introduced changes to the framework last year, including the removal of minimum investment ticket sizes to improve access for retail investors and flexible fund rules with an increased pocket for liquid investments and more flexible risk diversification requirements.
Elona Morina, Policy Advisor at the European Fund and Asset Management Association (EFAMA), says one success of the regime has been its ability to funnel capital to sustainable products.
She cites 2022 data as evidence: “There has been a total of €5.3 billion (US$5.7 billion) in ELTIF with a specific ESG reference compared to €2.4 billion in 2021. And that €5.3 billion corresponds to more than 47% of the ELTIF total. By the end of 2022 we had 20 products with an ESG reference, and under the Sustainable Finance Disclosure Regulation (SFDR) 13 were Article 8 and four of them were Article 9.
“Data clearly shows that it is used as a vehicle to facilitate investments in environmental and sustainable projects.”
Alexander Denny, Managing Director, European Private Wealth at private equity investment house Pantheon, says the changes made to ELTIF, such as the possibility of evergreen and semi open-ended fund vehicles, should encourage greater use in the market.
“I suspect right the way across the investment management industry in general it will be a preference on an ongoing basis, due to the sheer scale of capital needed in these infrastructure projects and the need for a greater pool investors that you can ask to provide capital so you can get access to a big deal flow.”
Looking more broadly at other policy incentives to encourage long term capital, he says the UK should introduce more tax incentives akin to those in the US’ Inflation Reduction Act. He also said requirements for independent financial advisors to discuss products such as LTAF with clients would help too.
