Introduction
The European Long-Term Investment Fund (ELTIF) is a European investment vehicle that was introduced for economic policy considerations, to provide additional financing opportunities to certain industries and companies. Although the European Commission launched the ELTIF in 2015, relatively few ELTIFs have been authorised since then. As of July 2023, only 95 ELTIFs existed according to ESMA’s public register. Most of these were issued in Luxembourg, France, Spain and Italy.
This year, however, the ELTIF has been subject of much discussion, especially in Germany. Why? The ELTIF Regulation has been fundamentally revised recently. The new regulations will come into force on 10 January 2024, bringing a variety of changes. We are taking this reform as an opportunity to compare the new ELTIF with the open-ended real estate mutual fund and to highlight potential advantages and disadvantages of the new investment product.
FURTHER INFORMATION
Investment Assets
The ELTIF is a multi-asset product. Unlike the open-ended real estate mutual fund, the ELTIF is not limited to a strict investment catalogue. Rather, an ELTIF’s eligible investment assets can be divided into two asset categories:
- Investments can be made in so-called “eligible investment assets”, which are generally illiquid and require a commitment for a certain period. These include real assets (including real estate, infrastructure for communications, environment, energy or transport, social infrastructure), equity or equity-like instruments of “qualifying portfolio undertakings”, loans to “qualifying portfolio undertakings”, and shares in target funds which in turn invest in ELTIF-eligible assets.
- ELTIFs also may invest – presumably for the purpose of liquidity investment – in all assets eligible for UCITS.
Open-ended real estate mutual funds may only invest in real estate and rights equivalent to real estate; property under management; equity interests in real estate companies; and certain securities, money market instruments and bank deposits for the purpose of liquidity investment.
ELTIFs therefore have a significantly broader range of investment assets than open-ended real estate mutual funds. The broad investment options in real assets are particularly interesting, as this considerably increases the flexibility of asset managers. The only prerequisite for a real asset is that it has an income value due to its nature or type, which offers a wide range of investment opportunities. This makes it possible not to limit the risk to just one asset class, to better diversify and, if necessary, to combine investments that are factually related (e.g., real estate and equity interests in project development companies). In comparison, open-ended real estate mutual funds may only invest in real estate.
Portfolio Composition and Diversification
While an ELTIF originally had to invest at least 70% of its capital in eligible investment assets, this ratio has now been corrected to 55%. At least 55% of the capital of the ELTIF must therefore be invested in the above-mentioned “eligible investment assets”.
The diversification ratios also have been adjusted. An ELTIF may now acquire a maximum of 20% of its capital in instruments of, or loans to, the same qualifying portfolio undertaking; a maximum of 20% of its capital in a single real asset; and a maximum of 20% of its capital in units of a single ELTIF, EuVECA, EuSEF, UCITS or EU AIF, and a maximum of 30% of an ELTIF, EuVECA, EuSEF, UCITS or EU AIF.
Open-ended real estate mutual funds must invest more than 50% of the value of the investment fund in real estate, with no more than 15% of the value of the investment fund being attributable to a single property. In addition, the total value of all properties whose individual value exceeds 10% of the value of the investment fund may not exceed 50% of the value of the investment fund. Properties in the state of development may not account for more than 20% of the value of the fund. A maximum of 49% of the value of the investment fund may be invested in bank deposits, money market instruments, investment units, securities and REITS. The capital management company must also ensure that an amount equivalent to at least 5% of the value of the investment fund is available for the redemption of units.
Borrowing
To leverage their assets, ELTIFs can borrow. The regulators increased the leverage ratio from 30% to 50% of the ELTIF’s net asset value. The manager of the ELTIF must indicate in the prospectus whether it is intended to take out cash loans as part of the investment strategy and what is the cap for borrowing. However, the cap does not apply until a maximum of three years after the date on which the distribution of the ELTIF has commenced.
In contrast, the debt ratio of open-end real estate mutual funds is a maximum of 30% of the market value of the properties belonging to the investment fund. Additional short-term borrowing may not exceed a debt ratio of 10% of the net value of the investment fund.
The higher borrowing limit of the ELTIF compared to the open-end real estate mutual fund may bring advantages. In particular, it enables an ELTIF to increase leverage and thus possibly achieve higher returns. However, it should be noted that the respective calculation bases for the leverage ratio differ, so that the ELTIF’s borrowing limit, which initially appears to be significantly higher, may have a smaller effect than it appears at first glance.
Liquidity Requirements and Redemption Options
An important difference between ELTIFs and open-end real estate mutual funds is their liquidity requirements and redemption options.
ELTIFs are geared towards long-term investments. Therefore, they are basically closed-end funds. As a result, investors in an ELTIF cannot request redemption of their units before the end of the term specified for the ELTIF. A clear date for the end of the ELTIF’s term must be specified in the investment conditions or the articles of incorporation of the ELTIF concerned.
Under certain circumstances, however, the investment conditions or the articles of incorporation of an ELTIF may provide for the possibility of unit redemptions during the term. For this purpose, an investor-related minimum holding period with an individual time period must be specified. The manager of the ELTIF also must demonstrate that there are adequate redemption arrangements and liquidity management instruments for the ELTIF that are consistent with its long-term investment strategy. The ELTIF’s appropriate redemption policy must clearly state the procedures and conditions for redemptions. Finally, the ELTIF’s redemption policy must ensure that redemptions are limited to an individually determined proportion of the ELTIF’s UCITS-compliant investments, and that investors are treated fairly by granting redemptions on a pro rata basis where applicable. Thus, investors do not have to be contractually promised an unconditional, comprehensive redemption of their shares during the term of the ELTIF.
In contrast, units of open-end real estate mutual funds may be redeemed after a minimum holding period of 24 months and are subject to a redemption period of 12 months. If, at that time, the liquid assets available in the real estate mutual fund are not sufficient to pay the redemption prices of the units to the investors, the redemption of the units must be suspended. In this case, the assets of the real estate mutual fund must be sold quickly to raise liquidity in order to be able to meet all redemption requests. If this is not achieved within three years, the fund must be wound up.
Distribution
ELTIFs can be authorised for cross-border marketing throughout the European Union via the EU passporting procedure for AIFs. This only requires notification to the competent authority of the home Member State. In contrast to other AIFs, distribution can take place both to professional investors and to retail investors in other EU Member States. The ELTIF is likely to be an increasingly attractive investment vehicle for retail investors, since the reform abolishes the previously applicable minimum investment amount of EUR 10,000 and the 10% cap for private investors with liquid assets of less than EUR 500,000.
The pan-European distribution of open-end real estate mutual funds, on the other hand, requires individual, nationally regulated approval by the competent authority of the relevant Member State. Only cross-border distribution exclusively to professional investors is possible without authorisation with the help of AIF passporting.
Therefore, the ELTIF, like the UCITS, represents a European investment product which can be distributed cross-border without national authorisation to professional investors as well as to retail investors, thus facilitating distribution compared to the open-end real estate mutual fund.
Conclusion
Because of its broad investment spectrum, increased borrowing limit and cross-border distribution possibilities without authorisation even to retail investors, the ELTIF could represent a real alternative to the open-end real estate mutual fund. While the cross-border distribution of a real estate mutual fund is usually laborious due to the effort involved in obtaining the required authorisation in the respective Member State, with an ELTIF it is sufficient to file a notification with the competent authority of the home Member State. The feared scenario of a redemption suspension, possibly followed by a forced liquidation of the fund, could also be avoided in an ELTIF through appropriate contractual arrangements.
