Ireland is one the main domiciles in Europe for Alternative Investment Funds (AIFs) and has been at the forefront of developments in the space for several years.
“Alternative Investment Funds are investment vehicles that diverge from traditional fund structures,” explains Joy Kiely, chief executive of BNP Paribas Fund Administration Services (Ireland). “These funds pool capital from various investors to deploy in a range of non-traditional assets such as private equity, hedge funds, real estate, and other alternative investment classes. AIFs often offer investors a broader array of investment strategies compared to more conventional funds.”
They differ from traditional funds in several important ways. “AIFs have a more expansive investment scope than traditional funds, including less liquid and more complex assets,” she adds. “Their regulatory framework often allows for greater flexibility in investment strategies, catering to sophisticated investors seeking diverse and innovative opportunities. AIFs are labelled alternative due to their departure from conventional investment options like stocks and bonds. They venture into unconventional asset classes, employing diverse strategies that may include leveraging, short-selling, or investing in less liquid markets.”
Diversification is among their main attractions. “AIFs provide investors with a chance to diversify their portfolios beyond traditional assets, potentially enhancing risk-adjusted returns,” says Kiely. “The flexibility of AIFs allows fund managers to implement innovative investment strategies, offering investors exposure to unique opportunities.”
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There are pitfalls, including increased risk. “The complexity and diversity of assets within AIFs can expose investors to higher levels of risk compared to traditional funds,” she explains. “And there are liquidity concerns. Some AIFs invest in less liquid assets, potentially limiting investors’ ability to redeem their investments promptly.”
Those risks have meant that AIFs have been mainly aimed at professional investors up until now. “In Ireland, there are currently two different broad regimes under which a collective investment fund can be regulated by the Central Bank of Ireland — the Undertakings for Collective Investment in Transferable Securities [Ucits] Directive and the Alternative Investment Fund Managers Directive [AIFMD],” says Philip Murphy, financial services tax partner with KPMG.
“The Ucits directive is focused on funds which invest in more traditional asset classes, and which target retail investors who don’t have the significant investment expertise or time and resources to research the relative risks and rewards of different investment opportunities. As a result, there is a high level of focus on investor protection in the context of the complexity of investments that can be held and aspects such as how much the collective investment fund is required to diversify when deploying capital from investors.”
Individual, or retail investors, have typically placed their capital in these traditional assets, which are easily understood particularly as they are usually quite liquid and produce regular income flows. “A 60–40 allocation approach would have been the tried and tested method for many individuals when investing, with 60 per cent of an investment portfolio being held in equities and the remainder in bonds or other fixed-income instruments from a risk diversification perspective,” Murphy adds. “However, there are a number of benefits which a collective investment fund can bring to an investor relative to investing directly in different pools of assets. These include enhanced diversification and therefore capital protection, access to the experience of a fund manager and also the time saved in trying to track and manage a portfolio as the value of investments ebbs and flows over time.”
These retail investors are becoming increasingly interested in AIFs, he continues. “AIFs have been in existence for almost 10 years, however [they] have only recently become a significant focus of retail investors. Why is that? The type of assets which AIFs invest in are usually more focused on long-term investment growth. Typical asset classes include real estate, infrastructure and credit. These types of assets are usually not very liquid and may therefore take several years to produce positive returns or any form of payback for an investor. In addition, these types of assets are inherently more complex which can be perceived as increasing investment risk. For this reason, alternative assets and AIFs have historically been preferred by institutional investors such as pension funds and insurance companies, who have a preference for longer-term stable growth. But retail investors are now seeing the benefit that AIFs can bring to their overall portfolio as the diversification into alternative assets can provide overall longer-term stability, particularly when the bond and equity markets are volatile.”
Accessing AIFs can be problematic for the majority of individual investors, however. “With AIFs it is accepted that the nature of investment will be more complex, and the regulatory regime includes rules which govern aspects such as how it values investment positions, capital and leverage requirements and other policy considerations,” Murphy explains. “There is also a requirement for the fund to appoint an Alternative Investment Fund Manager [AIFM] and for that AIFM to undertake specific functions which are targeted at protecting investor capital. In practice most AIFs are regulated in accordance with the Qualifying Investor AIF [QIAIF] regime, which has a minimum investor subscription of €125,000, reflecting the target professional investor base of these funds,” says Murphy.
And that minimum investment is a very high bar for retail investors to meet.
“Retail investors are now seeing the benefit that AIFs can bring to their overall portfolio as the diversification into alternative assets can provide overall longer-term stability, particularly when the bond and equity markets are volatile,” Murphy notes. “From a broader perspective, the asset classes held by AIFs can also resonate with investors more. For example, some AIFs invest in capital-intensive infrastructure assets like windfarms based in Ireland or abroad which a retail investor would not otherwise be able to access. Other AIFs step in and provide finance to Irish SMEs [small firms] where there is an inability to access bank funding, so there are potential broader economic and societal benefits. Investment strategies can therefore appeal more to investors relative to listed equities or bonds, particularly where the investments are in green assets, given the general increased focus on the environmental, social and governance agenda.”
However, this will change when the regulatory framework for European Long Term Investment Funds (ELTIFs) is implemented in Ireland in March. The ELTIF regime will be separate from the existing Ucits and AIFMD rules and will be targeted at funds which invest in real and other alternative type asset classes which would historically have been held by a QIAIF but will have no minimum subscription amount.
“There will be conditions that need to be satisfied where they are marketed to retail investors,” says Murphy. “The expectation is that this regime will allow retail investors to access the enhanced diversification they are seeking in their portfolios through greater exposure to alternative assets, whilst also meeting the requirements of fund managers who are trying to establish regulated funds to access this capital. The introduction of the enhanced ELTIF regime in Ireland is consistent with the current trend towards retailisation of AIFs and represents a complementary offering to the existing regulatory regimes and suite of legal vehicles which have made Ireland a leading fund domicile jurisdiction.”
The regulatory regime has been an important factor in Ireland’s success as a domicile for AIFs, Kiely concludes. “Ireland’s regulatory framework for AIFs reflects a commitment to fostering a dynamic and competitive investment landscape, allowing market participants to navigate the opportunities and challenges presented by these alternative investment vehicles.”