ELTIFs and Evergreen Funds. Is That a Good Match? 

One of the darlings of the Capital Markets Union, already at the time of its first introduction in 2015, ELTIFs were supposed to become the preferential tool for financing SMEs and infrastructure projects in Europe. And where pressures reasonably mounted after a less than successful first iteration of the regulation, shortcomings continue to be evaluated and corrected exclusively at product level.   

We don’t ever deny the value of fully synchronised rules. We have yet to see though how the application of the ELTIFs regulation could benefit from a different perspective. Where one of the goals of European authorities is also to have retail markets supporting via the ELTIFs the financing of the overall endeavours of the Union, green and digital transition included, it might help to look at the issues currently faced by this product also from the perspective of the consumers and the broader market. For them liquidity is king. No matter what.  

The Challenges Faced by ELTIFs 

The challenges for ELTIFs are multifaceted. The first iteration of the regulation allowed us to understand a side to them. The one relative to the penetration of this brand and the underlying long-term investment proposition in retail markets. We may conclude that part of that challenge lied in that ELTIFs were conceived as closed-end type of products with a fixed duration. Redemptions were essentially an exception to the rule, with some of the few ELTIFs launched on the market, since inception of the regulation, offering no redemptions whatsoever for the entire life of the product. For there having been no significant effort so far in creating a secondary market for these products in Europe, the lack of an easy exit window for retail investors during the lifecycle of ELTIFs has been one of the biggest hurdles encountered by the first iteration of the regulation. Coupled with scepticism for long-term investments as such in the retail markets, a few years after the introduction of the ELTIFs the picture became clear. Not as many launches as the European authorities wanted to see, mostly concentrated in certain domiciles of continental and southern Europe. Not the success expected from this product, which was supposed to become the new UCITS in the eyes of European authorities.   

Where the second iteration of the ELTIFs regulation took stock of these challenges and addressed some of the related shortcomings, once again at product level, there is of course another dimension to the evolution of the ELTIFs regulation. One that reflects the parallel evolution of alternative investments and private markets themselves. And recent developments in these markets, which take them in a slightly different direction from their traditional path, shaped in part how ELTIFs look like under the second iteration of the regulation. Success of the ELTIFs means making the regime attractive to alternative investment managers and adaptable to their needs. This is where ELTIFs and evergreen funds are mentioned increasingly more often together.  

The Recent Evolution of Private Markets 

We heard increasingly more often in the private markets space about so-called hybrid and evergreen funds. The preparatory works to the second iteration of the long-term investment funds regulation contain more than one combined reference to ELTIFs and evergreen funds. That is the case of the RTS issued by ESMA, where the cross reference to ELTIFs and evergreen funds comes into play in a couple of occasions. Mostly aspects related to redemptions and costs required fine-tuning for the European long-term fund being able to become a reliable frame of reference for hybrid and evergreen funds.  

We got accustomed to a specific reality in the alternative investments and private markets space over time. Investments tended to have a very homogenous time horizon and possibility of extension alike. Fund structures deployed to accommodate these investments would be structured to cater for these standards with closed end features. We can say it to be a fair conclusion that also the first iteration of the ELTIF regime would fall not too distant from these standards, if not for the easiness of marketing to retail investors, which was revolutionary at that time in our view.   

In the recent past we have witnessed an evolution of the dynamics of alternative investments and private markets alike. Time horizon of investments seems to be the part interested the most by these changes, which now stretch much farther than the original eight to ten years we got accustomed to. Different explanations are offered for this phenomenon. Some ascribe this change to a completely new approach of the private markets industry. The traditional focus on realising investments in a short timeframe has been replaced with a longer-term vision towards certain critical investments. Some others claim that the change is due to the perceived cumbersomeness of raising capital for additional funds, which may dictate the preference for hybrid or open-ended structures. These structures allow for investors to be periodically let out and in, without having to create new funds and raise capital for them separately. Lastly naysayers claim that the reason for the increase in use of hybrid and evergreen fund structures is different. More commercial in nature. Yields in this space are not what they used to be, nor do they materialise any longer in the traditional timeframe. This is the driving force behind decisions of general partners to extend the time horizon of their investments so as to buy time to deliver the returns that markets generally expect from these opportunities. 

Where the other side of the challenge of ELTIFs regulation is to appeal to alternative investment funds managers, the second iteration of the ELTIFs regulation has been morphed to accommodate as much as possible also hybrid and evergreen fund structures. 

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The Different Dimensions of Evergreen Funds  

The picture on hybrid and evergreen funds would not be complete had we not also looked at the distribution element, which is inevitably part of the equation. Alternative investments and other private markets opportunities, when presented in a traditional closed ended structure, leave untapped a sizeable share of the market.  

And where novelty of alternative investments and private market opportunities wore out for institutional investors, new avenues of distributions appear at the horizon. These are in first place the private wealth managers and related distribution networks. Surfing the recent wave of the so-called private markets democratization, it would be the more appropriate for ELTIFs and evergreen funds to go together. European long-term investment funds were conceived essentially with the retail investor in mind. Where at inception ELTIFs catered in principle to a more qualified white-collar type of retail investors, this approach has changed with ELTIFs II. Under the second iteration of the regulation, European long-term investment funds can now be sold to any type of retail investors essentially, without limitations of sort.   

Evergreen funds differ from more traditional structures for alternative investments at different levels. We touched already on the main difference pertaining to investment styles. Where traditional alternative investments strategies have a focus to realising investments in a shorter timeframe, hybrid and evergreen funds tend to cater for a more patient investment approach. That is usually characterised by holding for longer on to selected investment opportunities. But it doesn’t stop there.  

The most intuitive additional differences between traditional private markets funds and evergreen funds are relative to structures, life and liquidity of these funds. Hybrid and evergreen funds are substantially open-ended structures with no statutory end date. Perpetual funds basically. With that it comes that these funds can offer liquidity to their investors periodically. Accordingly, these funds can let existing investors out and new investors in during their lifecycle. Lastly, hybrid and evergreen funds are characterised by an immediate deployment of the capital raised with investors. 

Most Critical Changes under ELTIFs II 

Adding in the perspective of hybrid and evergreen funds and highlighting some of the related developments in the alternative investments and private market spaces gives more colour to some of the changes made as part of the revamp of the ELTIFs regulation. 

It is noteworthy to mention on this point the amendments made to article 18 ELTIF regulation. Under the first iteration of the regulation for European long-term investment funds, redemptions were not allowed until either the end of the life of the ELTIF or of the mandatory lock-up period. Under the new rules governing ELTIF an element of duality is introduced in this part of the equation with the creation of a holding period. Accordingly, European long-term investment funds can now offer redemptions linked in time to the holding period rather than the lock-up period. The same holding period for redemptions can be applicable also to new entrant investors in ELTIFs. The point of the holding period is also tackled in the amendments made by the European Commission to the RTS issued by ESMA, which details the criteria to follow for the setting of holding periods for ELTIFs.  

The concept of holding period is not new in European regulation at all. A concept of required or recommended holding period was introduced already under the PRIIPs regulation. In the context of PRIIPs, this is as well the period when there is no potential early exit or redemption for investors. This period can but does not have to necessarily coincide with the maturity date of the product. For the ELTIFs that under the new regulation will be offered also to retail investors the principles of the recommended holding period under PRIIPs shall also apply. The role of ESMA with the RTS is to lay down criteria for establishing the holding period that are specific to ELTIFs. The main takeaway also from the amendments of the European Commission on the ELTIF II RTS is that any holding period should reflect the specific characteristics and features of the particular strategy at issue rather than be predefined and standardised at the level of the regulation itself. This is in line also with the spirit of the provisions on the recommended holding period enshrined under PRIIPs regulation.  

Conclusions 

Is it a fair conclusion that ELTIFs and evergreen funds are a good match. They better be. In our view some of the characteristics of the ELTIFs regime are unbeatable on the marketability of this product and broader distribution capabilities. That is compared to any other AIF structure that could be used for the same purpose, including structures that can be made available to retail investors. The easy marketability of ELTIFs should by itself drive the decision of managers to choose for the ELTIFs and evergreen funds combination. 

The ELTIFs regime mimics the successful marketing passport mechanism that dictated already the global success of UCITS for the past decades. It is possible to obtain marketing authorisations for ELTIFs across Europe by completing the process directly with the home state authority of ELTIFs manager. That is compared to retail AIF structures requiring a costly and lengthy second leg authorisation process for retail offer to be carried out directly with the national competent authorities in each and any member state that is a distribution target. Where that was not sufficient, ELTIFs II regulation has also scrapped the requirement to appoint a local facilities agent.  

In some European domiciles, there are also advantages in that annual supervisory fees are not applicable to funds under this regime. For managers with pan-European outlook and ambitions for distribution of their products this is certainly something to bear in mind.