Allocating capital to long-term illiquid assets requires a shift in focus from cost to value, according to panellists at the Pensions and Lifetime Savings Association’s investment conference.
Defined contribution scheme trustees have been urged to focus on broad value and member outcomes and embrace allocations towards private markets through Long Term Asset Funds and other structures.
Trustee boards needed to shift their focus from low cost to best value, broadening their definitions, according to panellists.
“We really do need to focus on shifting the focus from cost to value,” said Sonia Kataora, partner at Barnett Waddingham.
Often trustees find that private markets and illiquid assets are complex and opaque
Sonia Kataora, Barnett Waddingham
“Governance is another issue. Often trustees find that private markets and illiquid assets are complex and opaque.”
A question of fairness
On both counts it fell to consultants to help educate trustees and get them comfortable with the structures and risks involved in private markets allocations, Kataora argued.
She cited the relative complexity of liability-driven investment strategies as an example of how such issues can be overcome.
The shift in focus to long-term value is a core element of the work of the Bank of England’s Productive Finance Working Group, which is exploring how to facilitate more investment into long-term illiquid assets.
Iren Levina, senior adviser at the Bank of England and member of the working group, said it was “important to bear in mind broader things” other than costs as it was “possible to pay more and get more”.
The Department for Work and Pensions is analysing feedback on its consultation regarding the inclusion of illiquid assets in DC schemes.
As part of the consultation, the DWP plans to exclude performance fees from the charge cap, which was identified as one of the main barriers to investment in private markets.
Kataora warned that some performance fee structures were deemed unfair to pension scheme members, but Joanna Asfour, global head of consultant relations at Partners Group, said there were multiple structures that addressed this concern.
“One of the main concerns that keeps coming up is this idea about investor fairness,” Asfour said.
“It’s the idea of a member coming into a fund and paying fees for performance that they didn’t actually benefit from, [effectively] cross-subsidising somebody else’s performance.”
However, “well-designed performance fees” can ensure fairness for members through using appropriate methodologies that reflect the pricing mechanism of the fund and account for savers trading in and out, Asfour said.
She cited options including performance fees based only on “realised exits” — calculating the fee based on the price a manager achieves when selling a portfolio investment.
Asfour added that there was a significant amount of innovation taking place in the private markets arena, with managers exploring new structures and strategies to suit DC schemes, including the new Long-Term Asset Fund structure.
This was introduced by the Financial Conduct Authority in October last year as a way of improving the liquidity structure of funds invested in real estate, infrastructure and other illiquid assets.
“We think there will be more innovation in the LTAF space,” Asfour said.
“We know other investment managers are looking at LTAFs very closely. The FCA will consult on the LTAF for wealth management and IFAs later this year, so we are watching how that develops, so that the products that come to market have a place in the DC institutional investment universe, but also in the post-retirement and wealth space as well.”
Schemes should not be dissuaded by property market failures
Speaking at a separate PLSA panel, Rene Poisson, director of the Standard Life Master Trust and chair of the JPMorgan UK Pension Fund, cautioned schemes against being too easily put off the private market by past property fund failures.
Almost half (44 per cent) of respondents polled in the season said they were thinking of incorporating private markets into their UK DC schemes, while 23 per cent said they had already done so, and a further 14 per cent said they were starting to incorporate private markets.
The desire for higher risk-adjusted returns over the long term was the principal motivation, cited by 54 per cent of respondents, while 27 per cent cited enhanced portfolio diversification.
Laura Myers, partner and head of DC at LCP, raised the issue of gated property funds, however, which have often been cited as reasons to be wary of investing in private markets and certain illiquid asset classes in particular.
Many property funds were “gated”, or suspended, during the 2008 financial crash, following the Brexit vote, and again after the Covid-19 pandemic, leading to complaints from stranded investors, and further suggestions that illiquid assets like property funds were incompatible with the daily dealing requirements of most DC schemes.
Dominic Byrne, BlackRock’s head of Emea DC strategy, acknowledged the need for members to understand the implications of illiquid investments, and stressed a general need “to have solutions and structures that are more adept at owning illiquid assets”.
Poisson, meanwhile, said it was the question “I was asked most often when we implemented our solution”, but added: “It’s not obvious to me that it’s [the biggest] problem.”
He accepted that some people had been “caught out”, but said that in the context of a default fund with ongoing monthly contributions, “as long as I can get decent daily pricing so that I can operate fairly as between an exiting member and an incoming member”, it is less liquid and illiquid investments like property funds that are still manageable.
Annuities make slow comeback as retirees look for income certainty
After a decline in annuity sales following the pension freedoms, the market seems to have levelled off with purchases accounting for around 10 per cent of total market share, according to the Pensions Policy Institute.
“It may not be the daily liquidity we all come traditionally to know and love, but we don’t actually need daily liquidity. With fair pricing and decent flows in the plan, I can manage the default. And, indeed, I can manage my self-select members using the flows that come into my default,” Poisson said.
“So it’s actually not a great concern. In the four-and-a-bit years, [the solution] is not a problem we’ve had, even through the period in which property funds got in trouble.”
Jennifer Ryan, head of UK institutional client business at BlackRock, added: “I think a single asset versus a diversified portfolio gives me less flexibility, and so the design conversation [around default funds] is very important.”
