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The Retailisation of Illiquid Assets

Illiquid assets are not for retail

While asset managers have largely navigated COVID-19 – both in terms of investment performance and operational resiliency – a number of longer-term risks are starting to emerge. Ultra-low interest rates are unlikely to disappear anytime soon, nor will the widespread equity market volatility, both of which are going to negatively impact investment returns. In response, there are now growing calls by some in the industry for retail investors to be given easier access to illiquid asset classes such as private equity. NCI believe this is a mistake, and risks doing major harm to the industry’s reputation.

Leave illiquids for the institutions

In theory, there is a robust case for greater investment into illiquid assets. The collective performance of private capital managers – namely private equity and private debt – has been impressive recently, and both asset classes are attracting record inflows from institutional investors. In fact, distressed debt is one of the very few asset management strategies to have benefited from COVID-19. But that does not mean illiquid asset classes are suitable investment products for retail.

Firstly, the appetite among retail investors for illiquid assets is not there. Retail investors – young and old – want liquidity on a daily or weekly basis. Unlike institutions with long-term investment horizons, retail investors will simply not accept the 10-year plus lock up periods accompanying private capital strategies. This is one of the principle reasons why the ELTIF (European Long-term Investment Fund) – an EU fund structure designed to give retail investors and smaller institutions access to illiquid assets like infrastructure, loans and real estate totally failed to generate interest.

Going against the prevailing tide

Although a number of asset managers have repeatedly expressed frustration about some of the (many) flaws around investor reporting, templates such as the UCITS KIID (Key Investor Information Document) do serve a useful purpose insofar as they provide a digestible summary of what a fund’s core objective is. Unlike conventional equities and bonds, illiquid assets are complex instruments, as are the funds that invest in them. While explaining the operating model of a vanilla UCITS vehicle to retail clients is a fairly simple exercise, it is naïve for people to assume the same will be true for private capital, which use intricate distribution waterfall methods to allocate capital gains to clients.

Making illiquid assets available to retail investors also goes against the prevailing regulatory tide. The Financial Conduct Authority (FCA) in the UK is currently examining the liquidity risk management practices at asset managers following the Neil Woodford Equity Income Fund gating incident back in 2019 and the trading suspensions by a number of daily dealing property funds during the height of the pandemic. Any attempt by asset managers running illiquid strategies to broaden their distribution reach into the retail world would risk regulatory scrutiny given these recent events.

Is it worth the risk?

As enticing as it may be for managers to offer retail investors access to illiquid assets, it is not a sensible policy to pursue. The reputational damage, which the funds industry would face should something go spectacularly wrong – is too great. At a time when investment firms are gradually rebuilding trust with retail investors, shifting into illiquids would be a terrible and ill-advised move.