Alternative Investment Funds: An Industry Overview with a Deep Dive into Banking Solutions [whitepaper]
A Comprehensive Guide for Finance and Payment Professionals
Executive Summary
This whitepaper offers crucial insights for C-suite executives, senior financial professionals, and decision-makers in the Alternative Investment Funds (AIFs) sector seeking to enhance their banking operations and secure reliable financial partners. Key highlights include:- AIF Market Landscape:
- The EU AIF market reached €6.8 trillion in Net Asset Value (NAV) in 2022.
- Diverse investment strategies across funds of funds, real estate, and private equity present unique banking needs.
- Regulatory Considerations:
- The Alternative Investment Fund Managers Directive (AIFMD) governs EU AIFs.
- AIFMD II, set for 2026 implementation, will introduce new compliance requirements affecting banking relationships.
- Banking Challenges and Solutions:
- Traditional banks often struggle to serve smaller AIFs (< €100m NAV) efficiently.
- Innovative fintech solutions offer rapid onboarding, multiple IBANs, and enhanced compliance support tailored for AIFs.
- Operational Efficiency:
- Digital-first banking providers enable streamlined operations and cost reduction.
- API integration capabilities allow for seamless incorporation into existing financial systems.
- Risk Management and Compliance:
- Market risks and regulatory changes necessitate adaptive banking solutions.
- Advanced compliance frameworks and data security measures are critical for AIFs.
- Strategic Recommendations:
- For CEOs/CFOs: Evaluate banking partners based on their ability to support diverse investment strategies and regulatory compliance.
- For CIOs: Align banking services with investment strategies to optimize fund performance and operational efficiency.
- For CCOs/COOs: Implement robust compliance frameworks and leverage banking partners with strong regulatory expertise.
Or scroll down to read the whitepaper here
Table of Contents
- Introduction to Alternative Investment Funds (AIFs) and Market Overview
- Market trends and growth
- Distribution of AIF types
- Geographical distribution of AIFs
- Alternative Investment Fund Fees and Revenues
- Regulation
- Scope and Application of AIFMD
- Flexibility and Leverage
- Passporting
- Reporting Requirements
- AIFMD II: Upcoming Changes
- Depositary Requirements
- Industry Challenges and Risks
- Market risk and its impact on AIFs
- Banking issues and solutions for registered alternative fund managers
- Benefits of Narvi’s digital onboarding and compliance solutions
- Narvi's Comprehensive Banking Solutions
- Conclusion
- Actionable Recommendations when Selecting a Banking Partner for AIFs
Introduction to Alternative Investment Funds (AIFs) and Market Overview
Alternative investment funds (AIFs) come in many forms, employ a variety of strategies, and invest in a dizzying array of assets. This combination may be daunting to newcomers, but according to Joel Coleman, founder of alternative fund manager Hay Mews Capital, this diversity is the sector’s main asset for investors. “AIFs offer access to a wide variety of asset classes – from property and infrastructure to private equity and debt – as well as a broad range of investing strategies. They’re incredibly varied, meaning you have the flexibility to choose a fund that’s aligned with your financial circumstances, goals, and approach to risk and values,” Coleman said in May 2024. But first, what are investment funds? Their core role is to pool capital from multiple investors in a portfolio of assets. And it's a big business. According to data from the European Central Bank, at the end of Q2 202,4, the total assets of investment funds in the 20-member Eurozone stood at €18.5trn, with equities (€695.8bn) and debt securities dominating (€5425.4bn) the asset mix.These funds can be divided into two types; firstly, undertakings for collective investment in transferable securities (UCITS) funds, which are marketed to retail investors and currently have total assets of €9trn. The second type are AIFs, which are collective investment funds. These funds are not marketed towards the general public but they still have a small (less than 15% of net asset value, or NAV) amount of retail investor participation. ESMA data shows the 35,361 AIFs registered in the EU held around 36% of the trading bloc’s fund industry NAV at the end of 2022. Despite variety being one of the main attractions of AIF investment, it is possible to draw out some market trends.
Market Trends and Growth
AIFs have seen steady growth over the last decade; total NAV for the sector stood at €5.14trn in 2015, and despite a January 2024 report by the European Securities and Markets Authority (ESMA) that the EU AIF markets shrank slightly in 2022, the sector is still well ahead of this figure today. “The size of the EU AIF universe declined slightly to €6.8trn in NAV in 2022 (-3% compared with 2021). Overall, AIFs accounted for around 36% of the NAV of the EU fund industry at the end of 2022,” ESMA said.Distribution of AIF Types
Among AIF types, funds of funds account for 17% of the NAV, followed by real estate funds (16%), private equity funds (11%), and hedge funds (2%). The catch-all category of ‘other’ held the other 51% of AIF NAV, whose investment strategies vary widely and include liability-driven investment (LDI) houses.“The NAV of other AIFs declined significantly by 13% to €3.5tn. The fall reflects adverse bond and equity market developments. Adjusted leverage remained contained at aggregate level at 124% of the NAV, with moderate and varying liquidity risks,” ESMA said. Despite the average NAV of AIFs standing at €200m, the sector is dominated by a few mega funds (with a NAV over €1bn). In 2022, AIFs with a NAV larger than €1bn accounted for less than 4% of all AIFs but for 51% of the NAV, according to ESMA.Geographical Distribution of AIFs
The story of a small number of large funds dominating AIF NAV is also true in respect to fund location. “The AIF industry is concentrated in a few countries, with the top five accounting for 90% of the NAV. In 2022, Germany remained the country with the largest AIF industry in the EEA30 (32%), followed by Luxembourg (24%), France (14%, stable) and the Netherlands (10%),” ESMA said.There is a greater diversity depending on the underlying investment strategy of the AFM. Funds of funds tend to be domiciled in jurisdictions with a large fund management industry, such as Germany, Ireland, France, and Luxembourg, which collectively account for 78% of that segment’s NAV. Hedge fund AIFs are heavily concentrated in Ireland and Luxembourg, holding a combined 74% of the sector’s NAV, while PE funds are overwhelmingly domiciled in Luxembourg and France (72%). The outliers are real estate funds and ‘other’ AIFs, which are more evenly distributed.Alternative Investment Fund Fees and Revenues
Typically, fund managers make profits by charging a fee for managing the assets; these vary by manager and the underlying asset class, but they are typically higher than for more general funds. Hedge fund managers often adopt a ‘2+20’ approach, which breaks down into a 2% of AUM charge to pay expenses such as salaries and a 20% performance fee allocated to pay the fund's key executives and portfolio managers. Fund of Funds will charge more as they typically invest in an underlying basket of hedge funds and then charge an additional management fee over the top. In contrast, data from ESMA shows that the average fee for UCITs exchange-traded equity funds, which are generally the cheapest way to access stock markets, was 0.4% in 2023. In addition to aiming for higher returns than mainstream investment funds, AIFs are intended to bring portfolio diversity and, therefore, reduce the volatility of an investor's overall returns compared with investing entirely in stocks and bonds. Typically, actively managed stock market or fixed-income funds target a return that is a certain percentage ahead of the underlying benchmark, such as the EURO STOXX 50 or the Bloomberg Global Aggregate Index. Alternative funds often take an ‘absolute return’ approach, which seeks to make returns for investors irrespective of the underlying market performance. One such vehicle is the Cantor Fitzgerald Alternative Investment Fund. “It is a process-driven absolute return fund. The fund may hold cash from time to time in order to protect capital. The fund does not reference a benchmark; instead, it targets a return in excess of 7% per annum for the investor, notwithstanding how equity markets perform,” the fund said on its website.Regulation
The European Union introduced the Alternative Investment Fund Managers Directive (AIFMD) in July 2013 to create a harmonised regulatory framework for alternative funds distributed within the trading bloc. “The AIFMD was introduced as a reaction to the financial crisis, in a bid to bring greater transparency and oversight to the institutional funds sector. Prior to the AIFMD, in many EEA Member States, institutional funds and their managers were subject to relatively light-touch regulation, compared to the more stringent regulation of retail funds,” law firm Latham & Watkins said. The directive applies to all fund managers operating in the EU, irrespective of where their underlying assets are located.Scope and Application of AIFMD
Contrary to the UCITS directive, which covers investment vehicles aimed at retail customers and provides prescriptive rules over the products they sell, AIFMD is focused on the fund management companies themselves. This reflects the far greater diversity in the AIF sector relative to UCITs and is intended to avoid the bureaucratic burden of creating a common set of product-specific rules for each AIF category.Flexibility and Leverage
As a result, AIFs have greater flexibility in terms of asset allocation and diversification rules than funds marketed to retail investors under the UCITS banner, which must follow strict rules over areas such as exposure limits and risk concentrations. Under AIFMD, alternative fund managers also have greater room to use leverage, and they can invest in a broader range of asset types, including underlyings such as commodities, mortgage-backed securities, and infrastructure.Passporting
The directive also enables what is known in EU financial jargon as ‘passporting.’ In theory, this allows for funds in one member state to be marketed and sold in another without any further regulatory hurdles, but leading law firm CMS said in a recent report that the reality is more complex. “The EU Commission promoted passporting rights as one of the key benefits for hedge funds, private equity, real estate, and other alternative investment fund managers authorised under AIFMD. However, we are now experiencing impediments to the passporting rights as certain domestic regulators are imposing ‘border controls’, and fund managers need to pay fees and comply with various other requirements in order to market their funds cross border,” said CMS.Reporting Requirements
AIFs are required to file reports to the regulator in the country they are domiciled annually, covering details such as pay, assets, as well as filing a full set of accounts. There are some exceptions, however, according to law firm Linklaters. “Article 3(2) of AIFMD contains an exemption for managers of smaller funds. AIFMD will not apply to AIFMs whose assets under management (AUM), including leverage, do not exceed: €100m; or €500m,” Linklaters said. Funds with an AUM which is below the threshold are not required to report to regulators, but they still need to register with authorities. In EU parlance, the above threshold funds are referred to as ‘Authorised AIFMs,’ whereas those below this level of AUM are known as ‘Registered AIFMs.’AIFMD II: Upcoming Changes
Two of the main centers for registered AIFMs are Luxembourg and Malta. According to data from Luxembourg's regulator, The Commission de Surveillance du Secteur Financier, in its July 2024 sector survey, the principality is home to a large number of smaller-sized AIFs, with 63% of its 9019 AIFMs recording a NAV of less than €100m.The EU’s approach to regulating AIFMs is being overhauled. In November 2023, the EU announced AIFMD II would be brought onto the statute book, and it is expected to enter into application in the first quarter of 2026.According to French Bank Société Generale, the latest iteration of AIFM is ‘an evolution more than a revolution.’ In addition to Brexit-inspired provisions over the derogation of investment authority, it also includes rules on liquidity risk management and loan exposures. “Among the key elements, the amending directive modernizes the framework for liquidity management tools, clarifies the EU framework for funds that provide loans to companies, and introduces enhanced rules for delegation by portfolio managers to third parties. It does not alter the requirement that the depositary must be located in the country in which the fund is domiciled, even though it grants exemptions to certain States,” Société Generale said. One such state is Malta, according to local law firm Mamo TCV. In an April 2024 analysis of AIFMD II, it said the latest version of the regulatory framework could give a flip to Malta’s alternative investment industry because locally domiciled AIFMs can now choose a banking provider (depositary) from another EU state. “Compliance with these new requirements could boost investor confidence, attracting more institutional and professional investors to Maltese AIFs managed by Maltese AIFMs whilst being able to choose an EU depositary outside of Malta,” Mamo TCV said.Depositary Requirements
Authorised AIFMs are required by the EU to appoint an entity to manage its cash flows - an independent depositary in regulatory jargon - for each investment fund it manages.The depositary can be an EU credit institution, or investment firm, or institutions entitled to act as a UCITS depositary, and these depositaries must be established in the home member state of the AIF. Meaning a Luxembourg-based fund manager must use the services of a local firm to manage its cash. Authorised firms in Malta may now have greater flexibility over EU depository regulations, but Neil Ambikar, CFO and Co-founder of Finnish electronic money institution Narvi, said that registered outfits in the majority of EU member states will face a challenge in obtaining a fundamental business requirement – banking services. “The problem a lot of registered alternative fund managers, whose NAV is below the €100m regulatory threshold, face is that banks don't really want to work with them because the compliance work for smaller funds is just as complicated as for larger alternative fund managers. It might take several months for a bank to onboard these companies, and the amount of compliance involved in maintaining these accounts makes them unprofitable,” Ambikar said. Narvi can work with registered alternative fund managers; as a Finnish electronic money institution, it is not technically a bank, but it is able to provide depositary services for AFMs with an NAV of just a few million euros.Industry Challenges and Risks
Given the nature of AIF business the core challenge is market risk – that the fund manager experiences losses due to factors that affect the overall performance of the financial markets.Market Risk and Its Impact on AIFs
For funds which adopt the ‘2 and 20’ approach to charges, a fall in the value of the underlying investment will reduce the amount of management fees they receive. Major falls in asset values could threaten the viability of the fund, and the recent move by the EU to overhaul the AIFMD framework was partly driven by fears that misuse of leverage by fund managers could threaten financial stability - a key post-GFC concern for global regulators. The global rise in interest rates during 2022 was cited in the ESMA’s latest AIFMD risk assessment, which focussed on the potential risks posed by real estate funds. The European securities regulator found that while there was a limited exposure at an individual fund level, they posed a potential systemic risk in countries where they own a large chunk of the overall property market. “This is the case in Ireland where the Central Bank of Ireland (CBI) imposed leverage limits for those funds,” the ESMA report said. The largest chunk of the AIF market - others - is also of interest to regulators in particular liability-driven investment (LDI) funds, which gain leveraged exposures to the UK government bond market, which experienced severe short-term volatility following the disastrous mini budget by the UK short-lived Prime Minister Liz Truss. “Following the severe stress experienced by LDI funds in September 2022, authorities in Luxembourg and Ireland communicated on the suitable levels of resilience those funds should maintain,” the ESMA report said.Banking Issues and Solutions for Registered Alternative Fund Managers
Unlike traditional lenders, which often require new accounts to be opened at a physical address, a process which Ambikar said is often paper-based and can take several months, Narvi offers a totally digital onboarding process over a much condensed time frame.Narvi is also able to offer banking service to another type of fund manager which can find banking challenging – securitisation funds. These are special-purpose entities that sit outside of AIFMD. Malta has adjusted its financial legal framework so that an AIF can only be constituted as a collective investment scheme.“[This] leads to a situation whereby under Maltese law, a securitisation vehicle cannot be an AIF (since it is not a collective investment scheme) and thus falls outside the licensable remit of the AIFMD. The above has allowed fund managers to structure certain parts of their business and services in a more flexible manner,” said Dutch compliance specialists TMF Group.The greater flexibility offered by the Maltese framework provides options for securitisation vehicles domiciled on the island, but the process of finding a traditional banking services provider in other jurisdictions can be complicated, said Ambikar.“These entities face similar issues with banks as registered alternative investment funds. Because they sit outside the AIFMD regulatory framework, it provides a compliance headache for traditional banks, but Narvi is able to serve them. The same is true of private alternative investment funds - such as ones which are providing services to friends or family. The rough rule of thumb is if you are not marketing the fund then it doesn’t need to be regulated. Which in turn leads to issues over obtaining banking services,” said Ambikar.Benefits of Narvi’s Digital Onboarding and Compliance Solutions
Narvi Payments offers 10-minute digital onboarding, which means clients, when approved by the compliance department, have remarkably fast access to a bank account. This account can also have three or four admin users and as many IBANs as required so that all investment funds can be managed separately. “Each of the IBANs will generate its own bank statement; they are completely segregated, and it's effectively the same as having multiple bank accounts. Narvi also provides users with API so clients can automate the bank account into their platform,” said Ambikar. Narvi is headquartered in Euro Zone member Finland, which allows for effortless money transfer throughout the single market and all accounts are able to receive funds in dollars and pounds, as well as offering the ability to make payments in 60 different currencies. Each account also comes with its own relationship manager, which Ambikar said enables compliance issues to be resolved smoothly. “Narvi has really strong AML and compliance teams with a lot of experience at large traditional and neo banks. What is different is that Narvi provides a private banking level of service that enables us to give a view on a compliance issue in a few hours via a tailor-made and customised approach,” Ambikar said.Narvi's Comprehensive Banking Solutions
Narvi, a Finland-regulated Electronic Money Institution (EMI), offers a range of banking solutions tailored to the needs of alternative investment funds. Our digital onboarding process ensures quick and efficient access to banking services, including the ability to generate multiple IBANs for separate investment funds. Here are some key features of our business banking solution:- Global Payments with Zero Hassle: Send and receive SEPA and SWIFT payments in 100+ countries in a variety of currencies with a dedicated Finnish euro IBAN without delays.
- Simple, Fast Onboarding: Apply for an account online in under 10 minutes. Paperwork reduced to a minimum.
- Secure and Personalized Support: Enjoy robust security (2FA, multi-user access) and support from real people, not bots.
- Integrated Financial Services: Integrate our API from day one for seamless financial operations.
- Transparent, No Hidden Fees: Full regulatory compliance under Finnish law and a clear fee list.
The Way Forward for AIFs in 2025
As the AIF sector navigates complex regulatory landscapes, volatile market conditions, and increasing operational demands, the choice of banking partner becomes increasingly critical.Key takeaways include:- Market Dynamics: The EU AIF market, valued at €6.8 trillion in Net Asset Value (NAV) in 2022, demonstrates the sector's significant economic impact and growth potential.
- Regulatory Complexity: With the implementation of AIFMD II on the horizon for 2026, fund managers must prepare for new compliance requirements that will affect their banking relationships and operational procedures.
- Banking Challenges: Traditional banks often struggle to efficiently serve smaller AIFs, particularly those with less than €100m NAV, creating a need for innovative banking solutions.
- Technological Advancements: Digital-first banking providers are emerging as viable alternatives, offering rapid onboarding, multiple IBANs, and enhanced compliance support tailored for AIFs.
- Operational Efficiency: The integration of advanced banking technologies, including API capabilities, can significantly streamline operations and reduce costs for AIFs.
- Risk Management: In an environment of market volatility and regulatory change, adaptive banking solutions with robust compliance frameworks are essential for AIFs to manage risk effectively.
Actionable Recommendations when Selecting a Banking Partner for AIFs
For CEOs and CFOs:- Consult Legal and Accounting Departments:
- Action: Consult your legal or accounting department to ensure that the potential business banking service is suitable for your AIF in terms of location, jurisdiction, and licensing requirements.
- Benefit: This ensures that the banking service aligns with your regulatory and operational needs, avoiding potential compliance issues.
- Conduct Thorough Due Diligence:
- Action: Conduct thorough due diligence on potential banking providers to assess their financial stability, regulatory compliance, and service reliability.
- Benefit: This ensures that you choose a banking provider that is reliable and meets your operational and compliance needs.
- Assess Integration Capabilities:
- Action: Evaluate the integration capabilities of potential banking providers to ensure they can seamlessly integrate with your existing financial systems and processes.
- Benefit: This improves operational efficiency and reduces the risk of disruptions in financial operations.
- Diversify Banking Relationships:
- Action: Consider diversifying your banking relationships to include both traditional banks and neobanks to mitigate risks and enhance flexibility.
- Benefit: This provides a safety net and allows you to leverage the strengths of different banking providers.
- Align Banking Services with Investment Strategies:
- Action: Ensure that your banking providers support your chosen investment strategy and provide the services you need.
- Benefit: This ensures that your investment strategies are optimized and that you are taking full advantage of the banking services available to you.
- Engage with Regulatory Bodies:
- Action: Engage with regulatory bodies and industry associations to stay informed about upcoming regulatory changes and industry trends.
- Benefit: This helps in proactively addressing regulatory challenges and staying ahead of industry developments.
- Implement Robust Compliance Frameworks:
- Action: Implement robust compliance frameworks to ensure adherence to regulatory requirements and maintain operational integrity.
- Benefit: This helps in avoiding regulatory penalties and maintaining the trust of investors and stakeholders.
- Monitor Regulatory Changes:
- Action: Continuously monitor regulatory changes and updates to ensure that your banking providers and internal processes remain compliant.
- Benefit: This ensures that you are always in compliance with the latest regulatory requirements and can adapt quickly to changes.
- Enhance Data Security Measures:
- Action: Enhance data security measures by implementing advanced security protocols, conducting regular security audits, and choosing a business banking service that has robust security features developed.
- Benefit: This protects sensitive financial data and ensures the security of your banking operations.
Published October 31, 2024. Sources checked October 18, 2024.Author:
Aaron Woolner is a financial journalist with over a decade of experience covering banking, insurance, fintech, and regulatory topics. Having led editorial teams at prominent publications like Capital.com and Asia Risk, Aaron delivers informed and compelling insights from across Asia and Europe.
Aaron Woolner is a financial journalist with over a decade of experience covering banking, insurance, fintech, and regulatory topics. Having led editorial teams at prominent publications like Capital.com and Asia Risk, Aaron delivers informed and compelling insights from across Asia and Europe.
What We Offer
Narvi Payments Oy Ab is an Authorized Electronic Money Institution (EMI). Narvi’s EMI license is granted by the Finnish Financial Supervisory Authority (FIN FSA) with the registration number 3190214-6. Narvi’s license is Passportised to all European Union countries.
Built and regulated in Finland© 2024 Narvi. All Rights Reserved.
v1.121.0