Investing in Less Liquid Assets

New guides designed to help defined contribution (DC) pension schemes understand the key considerations and risks around investment in less liquid assets has been published by a pensions industry working group convened by the Bank of England, the Financial Conduct Authority (FCA) and HM Treasury. Isio’s Jacob Bowman and Neil Otty were part of the working group. 

Executive summary

UK workplace Defined Contribution (DC) pension schemes are an increasingly important vehicle for saving for retirement. Ten years since the launch of automatic enrolment in 2012, there are 18 million active savers in UK workplace DC schemes¹. Over this period, their assets have increased from around £200bn to over £500bn, and are expected to double to £1tn by 2030.

As UK DC schemes have developed and grown in size, the range of investment opportunities available to these schemes has increased significantly. And this is likely to increase still further in the years to come. For example, UK DC schemes currently invest relatively little in less liquid assets, compared to UK Defined Benefit (DB) pension schemes and DC schemes in other countries, such as Australia. This reflects several factors, one of which is the important focus of the UK DC pensions industry – across the entire supply chain – on keeping costs low. Investing in less liquid assets tends to be more expensive and they may take some time to generate value; some of them may fail to do so. However, some UK DC schemes are now starting to consider whether and how allocating to less liquid assets as part of a diversified portfolio within a default arrangement could improve member outcomes. This can be for a variety of reasons including improving the potential risk-adjusted return on member savings, net of costs and charges, reducing risk through greater portfolio diversification and assisting net zero transition and sustainability objectives.

These considerations could be particularly pertinent in the context of relatively slow economic growth by historic standards, demographic trends and growing concerns around adequacy of savings for retirement. While investment in less liquid assets by itself cannot ensure adequate savings in retirement, it could help close the gap. For example, estimates suggest that a 22 year-old new entrant to a default DC scheme with a 5% allocation to venture capital / growth equity could achieve a 7-12% increase in total retirement savings². 

There are 18 million active savers in UK workplace DC schemes.

Reflecting the importance of this issue, the Productive Finance Working Group was established to develop practical solutions to the barriers to investment in less liquid assets. The Group has identified the barriers faced by the DC pension schemes as the main areas of focus. In 2021 the Group published a report³, setting out the key issues and recommendations for industry and the official sector that could create an environment in which DC schemes and other investors could benefit from investment in long-term, less liquid assets, where appropriate. One of the Group’s early deliverables was also to consider what is required to ensure the Long-Term Asset Fund (LTAF) – a new FCA-authorised fund structure for investment in less liquid assets – is operationally, commercially and legally viable, alongside other existing structures.

In response to the recommendations in that report, the Group has been taking concrete steps to remove barriers and raise awareness of the key considerations around investment in less liquid assets and to give decision makers the necessary tools to consider investing in such assets, when in members’ interests. To facilitate this, the Group has produced this series of guides for trustees, employers and other key DC scheme decision makers, covering key issues around investment in less liquid assets within default arrangements, including:

• Value for money: To help shift the focus from minimising cost to a more holistic value assessment, this guide outlines a process for assessing value for members from investing in less liquid assets and provides case studies on how that could work in practice for different types of DC schemes.
• Performance fees: To help DC schemes select, negotiate and co-create performance fee structures that could meet their members’ needs, the guide sets out key principles and maps them to specific features of performance fees to highlight their implications for DC schemes.
• Liquidity management: To support robust liquidity management and give DC scheme decision makers the necessary tools, the guide outlines how DC schemes can meet the liquidity needs of their members, while investing in less liquid assets, by managing liquidity at two levels – the DC scheme and underlying fund levels.

¹See Corporate Strategy Pensions Future | The Pensions Regulator

²See Oliver Wyman BBB The future of defined contribution pensions.

³See A Roadmap for Increasing Productive Finance Investment | Productive Finance Working Group September 2021