An increasing number of funds and other non-bank vehicles are being used to attract institutional capital for fund commercial real estate (CRE), infrastructure, project finance and other longer-term, real assets, according to Fitch Ratings.
In a report entitled
‘European Funds Discover Real Assets’
, the credit ratings agency (CRA) comments that in Europe, in particular, a notable ‘funding gap’ exists for longer-term ‘real assets’. Estimated at around €36bn by global property services group DTZ, the shortfall results from the pullback by banks and the only gradual return of commercial mortgage-backed securities (CMBS).
Structural changes in the funding markets for longer-term real assets are being driven by regulatory changes, such as the Basel III and Solvency II capital adequacy regimes, that have led to a fundamental shift in the risk appetites of the banking and insurance sectors to act as ‘buy and hold’ lenders for these (and many other types) of assets. While Basel III does not come into full effect until 2019, its market impact already is being felt.
Closed-end funds, rather than those that are open-ended and offering regular investor redemptions, seem to be the preferred vehicle for funding real assets, which are usually illiquid, term assets. Typically, these funds would have a life of at least seven to 10 years to allow time for the assets to mature. At the end of the fund’s life, remaining principal is returned to investors.
Fitch notes that the ‘lifecycle’ of a real asset fund can be delineated into three distinct phases: ramp-up, steady state and the wind-down or amortisation phase. The portfolio composition in the ramp-up and wind-down periods can materially differ from its steady state composition. It is important to consider all three phases when analysing a funds risk and potential return.
Most closed-end funds of real assets are reserved for institutional investors only, through fund structures such as Irish Qualifying Investor Funds (QIFs), Luxembourg Specialised Investment Funds (SIFs) or German SpezialFonds, although access can also be gained through other structures such as corporate entities and limited partnerships which can have ‘fund-like’ characteristics. Insurance companies and pension funds are the most likely target investors given the inherent long-tailed life of their liabilities. The funds are often offered to a limited number of institutional investors in the form of so-called club deals.
Many institutional investors could invest directly in term assets, rather than through a managed fund, says Fitch. Diversification, risk limits and professional third-party management may be factors in favour of accessing these markets through funds.
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