How DIY investors can gain exposure to illiquid assets

Laith Khalaf
5 August 2021

•    The PM and Chancellor are trying to ignite an ‘investment big bang’ to encourage investment into illiquid assets in the UK
•    The FCA is currently consulting on creating a new fund regime for a Long Term Asset Funds (open-ended funds which invest in illiquid assets) - the Chancellor has told parliament one will be launched by November 
•    DIY investors can already gain exposure to illiquid assets through investment trusts, VCTs, EIS and some open-ended fund in the property sector

Laith Khalaf, head of investment analysis at AJ Bell, comments:

“The Prime Minister and Chancellor are trying to get big pension funds to invest in unlisted companies to boost the UK’s economic recovery, but DIY investors can already gain access to illiquid assets like private equity, infrastructure and real estate within their SIPPs and ISAs. 

“Investment trusts offer investors access to these hard to reach areas of investment markets, because their closed-ended structure means they don’t have to sell underlying investments to meet investor withdrawals. The cost of that liquidity is reflected in the premium or discount the investment trust is trading at, which adds to the volatility of the investment. This is an area where investors do need to tread with caution, and should only have a small part of their portfolio invested, and be comfortable with the risks involved. 

“Investors can also invest in small unquoted companies through VCTs and EIS, while capturing valuable tax breaks. These are high risk investments only suitable for the most adventurous investors, and must be held for the long term in order to qualify for the relief that is paid up front,

“Illiquid assets have caused problems when married with open ended fund structures in the property sector, and in the collapse of the Woodford funds. Nonetheless the Chancellor is pursuing the creation of Long Term Asset Funds, which will be open-ended and yet invest in illiquid assets like infrastructure, private equity and real estate. In doing so, the government is trying to harness the vast wealth in pension funds to fund a large part of its green agenda, while also boosting the economic recovery by funnelling investment into small UK companies. The compromise will be the Long Term Asset Funds will have long notice periods, 90 to 180 days, perhaps even longer, so the managers can deal with investor withdrawals appropriately.

“Institutional pension funds don’t like to put money in investment trusts because of their ability to trade at a discount or premium, and their volatility. But many private investors are well practiced in buying investment trusts in their portfolios, and these vehicles already do a good job in providing exposure to illiquid assets, albeit with all the risks inherent in that approach.”

How to invest in illiquid assets

Investment trusts

There are plenty of investment trusts which offer exposure to illiquid assets, though they may not all be as UK focused as the PM and Chancellor might like. But investors are probably more concerned with creating a diversified portfolio of good investment opportunities rather than using their money to do a bit of flag waving. 

Pantheon International for example is an investment trust which invests in a global portfolio of private equity assets, while 3i Group offers exposure to private equity and infrastructure opportunities in Europe and North America. If it’s specifically green infrastructure investors are after, there is the bulging Renewable Energy Infrastructure sector to consider, containing trusts such as Greencoat UK Wind and The Renewables Infrastructure Group. To hold some private equity in a more diversified growth trust, investors might consider Scottish Mortgage investment trust, which has around 20% of its portfolio invested in unlisted equities.

Property funds

It’s possible to invest in commercial property funds through an open-ended fund, but as we have seen in times of market distress, these funds have had to shut their doors for considerable periods of time to investors wanting to leave. For exposure to commercial property, it’s probably preferable to opt for an investment trust which offers ongoing liquidity, even if that might be at a premium or discount to the value of the underlying portfolio. Alternatively there are funds and trusts which invest in listed property securities, an approach which mitigates the issue of liquidity, though leads to a greater correlation with equity markets and so doesn’t provide as much portfolio diversification. For instance, TR Property is an investment trust which invests mainly in listed European property securities, but also contains an element of direct investment into UK commercial properties.

VCTs and EIS

These tax wrappers offer investors exposure to small, unquoted companies with considerable tax breaks to boot. VCTs offer investors up to 30% tax relief on their initial investment, with tax-free dividends and growth. To keep the tax relief you must hold the VCT for at least five years. EIS also offer 30% up front tax relief, with tax-free growth and the potential to defer any previous capital gains rolled into an EIS. The tax benefits of these schemes are clearly very attractive, but the investments are very high risk and so only for very adventurous investors with a high tolerance for risk and loss.

Laith Khalaf
Head of Investment Analysis

Laith Khalaf started his career in 2001, after studying philosophy at Cambridge University. He’s worked in a variety of roles across pensions and investments, covering both the DIY and the advised sides of the business. In 2007, he began to focus on research and analysis, and has since become a leading industry commentator, as well as a regular contributor to the financial pages of the national press. He’s a frequent guest on TV and radio, and for several years provided daily business bulletins on LBC.

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