PLSA IC 21: Practical challenges around illiquid assets persist despite industry appetite

Pension schemes and their members have appetite for illiquid investments, such as infrastructure, but practical challenges continue to prevent further investment in these areas, according to industry experts.

Speaking at the Pensions and Lifetime Savings Association (PLSA) Investment Conference 2021, Brunel Pension Partnership CIO, David Vickers, stressed that there is a desire from members for further investment in these areas.

He stated: “We would, and our members would love us to, be involved in local infrastructure projects, and so we are kind of beholden to the government to a certain extent to create those projects.

"Actually with Boris' green plan etc there are opportunities coming up, but it takes those opportunities coming up to be presented and realised, and to be attractive, in a number of ways.

"For it to meet the social need that we’d like to invest in infrastructure as a UK local authority, but also make sense from a fiduciary perspective in order for us to earn the return that’s required from that particular part of the portfolio. So we’d welcome opportunities."

This was echoed by Willis Towers Watson investments senior director and LifeSight trustee lead investment adviser, Marc Bautista, who warned that there are both cost and logistical issues facing defined contribution (DC) schemes in particular.

He stated: “It’s not caution holding us back, the appetite is there. We’d like to introduce more illiquids into our portfolios, the only things holding us back are practical challenges, but we’re looking forward to working with other parties to further new solutions.

"As an investment house we love illiquids in a properly diversified return-seeking portfolio.

"It is really hard for DC, I mean cost is one aspect, but also if you invest via a platform the need for daily pricing and trading is a genuine hurdle.

"So within Lifesight we already have some exposure to illiquids, and we do that via smart low-cost liquid roots, so for example our approach to accessing core infrastructure and core real estate in a liquid way.

"But we’d love to do more and we are looking forward to market developments where we’re looking for solutions to overcome those practical challenges and incorporate more illiquids into a long term DC investment strategy because that's ideal in that context."

There are also issues facing defined benefit (DB) schemes, however, as Mercer chief investment officer EMEA & Asia for investment solutions, Niall O’Sullivan, stated that one of the big problems is that “people have almost a fascination with liquidity in their portfolio, sometimes a lot more than they actually need".

He continued: “What we see a lot is people aren’t exactly sure what their end destination is going to be; is it a buyout, is it maybe some sort of capital solution with their sponsor, is it a run off type situation?

“What happens is everyone assumes its number one, and they don’t own enough illiquid in their portfolio as a result.

"Whereas if you can sit down and do a holistic review of your strategy, say this is where I'm likely to end up and this is the illiquidity I can live with, you can harvest the returns.”

In response to a query around reputational risk, Nial also suggested that the move to “stakeholder capitalism being an input on shareholder prices has become a reality", explaining that certain behaviours will be "punished" by an increased cost of capital.

However, he emphasised that integrating reputational risk into a portfolio analysis is not trading one thing off, but “actually hopefully” enhancing the return profile and removing the risk.

This was echoed by Vickers, who stated that “these things aren’t mutually exclusive”, suggesting that the rise of social media and the rise of awareness has meant that reputational issues have been penalised “much quicker, much more broadly, and in the public chord of social media than ever before".

However, he stressed that these issues can run very deep, stating that CEOs need to know who their suppliers are, but also "who their suppliers' suppliers' suppliers are".

He continued: “Its about us as investors challenging our managers, challenging the corporations, challenging society and government to weed out these behaviours.

"But we are going to continue to get these reputational shocks as more things come to light because the further you look the more you dig the quicker these things are going to be unearthed.

"Reputational damage is catastrophic for firms and your punished much more quickly than you perhaps one has been historically."

Bautista added: “Reputational risk is absolutely an important risk factor, but its part of a broader issue of sustainable and responsible investment, and there are many ESG-related risk factors there.

“One of the core beliefs underpinning Lifesight approach is that the ultra-long-term returns that our members need can only come from an economic system that works, and that those returns will have more utility in a better world.

“We also believe that the zeitgeist continues to put more emphasis on reputational risks, on other environmental, social and governance (ESG) risks, and those kinds of externalities will increasingly be priced in, so they are financially material."

Alongside this, he emphasised the importance of imbedding ESG integration into the full investment approach, stating that whilst "lots of people talk a good game" it is important that this is integrated into defaults, as well as any self-select ranges.

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