Productive Finance Working Group publishes illiquid asset guidance

The Productive Finance Working Group has published new guidance to help defined contribution (DC) pension schemes understand the key considerations and risks around investment in less liquid assets.

The guidance, Investing in Less Liquid Assets: Key Considerations, aims to give DC pension fund trustees, sponsoring employers and investment consultants the tools to consider investing in assets such as venture capital, private equity, and infrastructure, where appropriate and in scheme members’ best interests.

It was produced by the Prodctive Finance Working Group, which includes a range of industry organisations, including the Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Association (IA) and the Pensions and Lifetime Savings Association (PLSA), as well as around 20 large DC pension schemes, investment managers and consultants.

The group noted that, as UK DC market has grown, the range of investment opportunities available to DC schemes has increased significantly, with some now starting to consider whether allocating to less liquid assets as part of a diversified portfolio within a default arrangement could improve member outcomes.

However, it acknowledged that there are risks to be managed, clarifying that less liquid asset classes may not be a good fit for all schemes.

In particular, the report emphasised that schemes will need to manage liquidity risk, suggesting that this can be achieved by evaluating the schemes’ future cash flows based on scenario analysis and stress testing.

The guidance also encouraged schemes to work with fund managers to ensure alignment between liquidity of the fund with that of the underlying assets and understanding a range of liquidity management tools.

Value for money considerations have also been included, as the guidance outlines a process for assessing value for members from investing in less liquid assets, to help shift the focus from minimising cost to a more holistic value assessment.

Alongside this, the report includes a guide on performance fees, outlining key principles and mapping them to specific features of performance fees, in order to help support DC scheme trustees in selecting, negotiating, and co-creating performance fee structures.

It also provides an overview of the key features and considerations around the fund structures potentially available to UK DC schemes, and the key considerations around due diligence on the investment managers and products.

To support implementation in practice, investment and employee-benefit consultants have also published a joint commitment to shift the focus from cost to value when advising DC decision makers, as well as a call to action for DC investment platforms to evolve their processes and systems.

Commenting on the report, ABI director general, Hannah Gurga, stated: “The creation of the guides is an important step to help pension professionals understand the opportunities and challenges of investing in illiquid assets, which can provide greater diversification and support the UK in reaching net zero objectives.

“We are proud to play a part in this industry-wide initiative and look forward to continuing to work with the Productive Finance Working Group to help unlock the sector's full potential for investing in the UK's long-term future.”

AIC chief executive, Richard Stone, added: “It is very encouraging that the guides identify investment companies as a way DC pension schemes can access less liquid assets.

“Their permanent capital structure makes them particularly suitable for capturing the illiquidity premium offered by alternative assets, such as infrastructure and private equity.

“Investment companies’ fund managers are able take a long-term view when constructing their portfolios. They are not forced sellers because of redemptions – avoiding the risks of liquidity mismatches.

“For DC pension schemes looking for exposure to less liquid assets, investment companies are the ideal vehicle. They offer strong performance over the long term, robust governance, active oversight of fees and the ability to trade on the stock exchange, making them the natural choice for illiquid assets.”

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