DC potential in investing in Illiquid assets

Providing access to illiquid assets in defined contribution (“DC”) schemes is becoming more and more topical.

Whilst defined benefit pension schemes in the UK are well positioned to take advantage of investing in illiquid assets such as private equity and infrastructure due to their long time horizon, particularly for larger schemes, illiquid assets are not typically offered within a DC scheme.

Investing in illiquids is a good idea. These types of assets typically provide enhanced returns, inflation linked payments and diversify risk away from listed equities and other asset classes.  There is also an added benefit that investment into assets such as infrastructure or social housing stimulates the economy.

There has been a push for schemes to invest in illiquid assets with government, FCA and tPR taking steps to make it easier for pension scheme’s to access these investments especially for DC schemes. Following last year’s budget, Aviva, HSBC, Legal & General, NEST amongst others have signed up to work with the British Business Bank to explore options for pooled investment in ‘patient capital’ (or illiquid asset classes).

This is encouraging and clearly positive steps are being taken, however, it does come with its own issues for DC schemes. Some of these include:

  • Many trustees have assumed that illiquid investments were not allowed as part of regulation and so have avoided them.
  • The fees on illiquid funds tend to be high and there is a concern about remaining within the 0.75% charge cap for the default strategy.
  • Illiquid assets such as private equity and infrastructure are complex and so trustees need to ensure they have the skills or expertise to understand them in order to manage risks before offering them to members.
  • The need for daily liquidity.
  • Communication to members about investing in illiquid assets.

As you can see there are a number of barriers preventing investment by DC schemes, but through better guidance from regulators, governments, investment advisors and other parties involved, trustees will be in a better position to take advantage of investments in illiquid assets.