In this paper, we discuss the amended regulation on European Long-Term Investment Funds (ELTIF 2.0), the latest evolution of EU Alternative Investment Funds (AIFs). The first version of this fund structure was introduced in 2015 and aimed to finance the real economy by channelling non-bank capital to long-term infrastructure projects and SMEs [1].
The ELTIF 2.0 regulation creates new opportunities to invest in private assets using an open-ended fund structure, aiming to help democratise investments.
This regulation includes several changes relative to its predecessor, ELTIF 1.0, and in our view establishes the ideal environment for strategies with allocations to private assets.
Several of these changes aim to facilitate access for retail investors to private assets, for example, by explicitly differentiating between ELTIFs for professional and for retail investors, with lower barriers and fewer constraints to investing, and by allowing these ELTIFs to be structured as open-ended funds.
The new regulation also has a significant impact on the structuring and distribution of funds incorporating private credit strategies.
In our paper, we discuss the new directive and the additional investment opportunities it brings, with a particular focus on private credit..
Private credit investments
We begin with a review of the risks and returns associated with private credit investments, the benefits of integrating private credit into multi-asset funds, and the strategic considerations underpinning investments in funds with private credit exposure.
The Global Financial Crisis of 2008 served as a catalyst for the rapid expansion of private credit markets, reshaping the financing landscape and driving increased interest in alternative lending channels.
We discuss the sources of risk and return from investing in private credit including the illiquidity risk premium, the duration risk premium, the role of leverage in private credit investments and its potential to augment returns, and how private credit strategies offer opportunities for return smoothing and consistent income generation.
We see an investment case for investing in open-ended funds that include private credit as a core component. The benefits include enhanced risk-adjusted returns.
The benefits of investments in private credit
- Higher gross yield: private credit has a higher gross yield compared to high-yield bonds with the same rating, supported by the yield premium that private credit offers
- Lower credit loss: private credit investments come with structural features (e.g., covenants) that provide more downside protection and higher recovery rates than traditional unsecured bonds with the same rating
- Lower volatility: private credit has less price volatility than high-yield bonds, providing more stable returns over the longer term
- Diversification: private credit is less correlated with traditional asset classes such as equity and bonds. It provides diversification by reducing volatility and increasing returns in a traditional portfolio.
References
[1] Small and medium-sized enterprises
