ELTIF & Operating model

While retail funds under ELTIF 2.0 are only slowly picking up demand due to the current interest environment, the positive longer-term views of the industry have not changed with regard to the allocation of retail investor money into alternative assets. However, an overlooked but crucial element for success lies in the operational readiness amongst asset managers, servicers and distributors.

The challenge for alternative asset managers: managing liquidity

Currently alternative investment fund (AIF) firms are actively investigating ways to broaden their product ranges by introducing semi-liquid fund structures that are suitable for a wider array of non-professional investors. An issue arises regarding the complex liquidity management that needs to be adapted for alternative funds for non-professional markets. 

Indeed, alternative asset managers have to adjust their investment processes to be able to invest in liquid assets, and provide for investor return and liquidity to satisfy redemptions from retail investors. 

They are also required to perform liquidity modeling for the fund to plan for (re-)investment and perform liquidity stress testing programs. Hence, asset managers must ensure that the chosen liquidity management tools cover retail investor needs in times of market stress to avoid a lock-in during times in which liquidity is potentially most needed.

The challenge for fund accountants: aggregating real assets and liquid assets

Most fund accounting systems have been designed in a way to facilitate the accounting for liquid (UCITS eligible assets) or illiquid assets (private equity, private debt, real estate, infrastructure). Fund accountants will therefore be required to find effective methods to aggregate liquid and illiquid assets when performing the calculation of the net asset value (NAV).

The challenge for registrar agents: providing connectivity to retail distribution networks and managing high frequency of subscriptions and redemptions

Most existing alternative investment funds have a limited number of institutional investors, are closed-ended, and operate on a commitment basis. For retail ELTIFs, the IT systems of the registrar agent must provide for connectivity to retail distribution networks, including distribution platforms connecting the local bank of the end investor with the ELTIF’s shareholder register through SWIFT messaging and nominee account structures. Only technical infrastructure that is set up in this way will be able to cope with the high number of retail investors and their subscriptions and redemptions. The execution of liquidity management tools, such as lock-up periods or redemption gates, will also add further complexity to the registrar agent’s operations.

The challenge for fund distributors: marketing the ELTIF product with retail investors

Until now, few alternative investment products have made it onto the shelves of retail banks or independent financial advisors. Success of ELTIF 2.0 will depend on the effectiveness of placing these products with the end investors and keeping the investor’s money in them through the investment cycle. Due to the described lack of experience with alternative investment products, significant investment into the education of the distribution network will be required.

What’s next?

The success of ELTIF 2.0 will be highly dependent on how and when the different players within the alternative investment value chain manage to adapt their operating models for this type of product. As such transformations can be lengthy, players who perform a timely impact assessment of ELTIF 2.0 on their organization will have a competitive advantage. As demonstrated by the various challenges described, retail ELTIFs embed many characteristics of UCITS products. Those players with experience in UCITS and AIFs may thus be put in a strategically better position.

Furthermore, technological advancements could potentially alleviate current hurdles. Specifically, tokenization (to convert the ownership of fund shares or units into digital tokens that represent an investor’s stake in the fund) is seen as a game changer by allowing for subscriptions and redemptions of fund shares on a secondary market instead of creating liquidity on the fund portfolio level. This innovation might prevent the inclusion of more liquid assets in the alternative retail fund portfolio and thereby preserve the alignment with the considerably higher return objectives that are normally generated with alternative investment strategies. Moreover, tokenization could facilitate easier and faster divestment due to real-time execution and settlement capabilities inherent to blockchain-based trading platforms. 

While these prospects sound promising, their application depends primarily on two factors:

• Firstly, blockchain technology has been incorporated into the Luxembourg fund law, but the widespread approval and adoption of tokenized retail investment funds have yet to occur. 
• Secondly, the widespread adoption of tokenized fund solutions is dependent not only on regulatory acceptance but also on the willingness of a sufficient number of market players to engage on such secondary platform venues to provide for required market depth and liquidity.

In a nutshell, the retailization of alternative assets offers a huge growth opportunity for the asset management industry by offering retail clients exposure to a suite of alternative assets which were traditionally reserved for professional and institutional investors. However, in order to gain full speed in this area the relevant steps have to be undertaken.

The opportunities outstanding require an adaptation of the country’s financial service providers and their adaptation to changing market demands. This adaptation includes creating educational tools to demystify the complexities of alternative investments as well as initiatives to educate potential investors as well as financial advisors about the details and potential of alternative investments.