Trustees should build a clear exit strategy into their funding and journey plans before investing in illiquid assets, according to a paper from Van Lanschot Kempen Investment Management (VLK).

In its report, Illiquid assets and the endgame: When you can check out, but struggle to leave, the firm argued that trustees should embed exit considerations into funding and journey planning from the outset, assessing whether legacy illiquid assets could influence a scheme’s chosen path based on size, complexity and time to unwind.

Where the original investment rationale still held, it said that trustees may be justified in running assets on to harvest value.

However, if underlying assumptions had changed, VLK stressed that schemes should plan an orderly exit and accept that some costs were part of re-optimising their portfolios.

Trustees were also encouraged to assess whether assets had genuinely added value relative to realistic alternatives after allowing for exit costs, in order to “separate emotion from economics”.

The report cautioned against dismissing illiquids entirely, noting they could still play a role, particularly for schemes considering run-on.

But it emphasised the importance of clarity before investing, including understanding lock-ups, trading frequency, exit costs, and the robustness of liquidity provisions.

Meanwhile, ongoing monitoring was described as essential.

The report stated that trustees should build expected return of capital into cashflow plans, identify underperforming or structurally problematic funds early, and weigh whether accepting a modest discount today may be preferable to a prolonged and uncertain exit.

The paper also highlighted the emergence of alternative trading venues and evolving secondary market solutions as potential new routes to price discovery and liquidity.

The recommendations come against a backdrop of improved funding levels across many DB schemes, which have shifted priorities towards securing benefits and de-risking.

Indeed, VLK noted that illiquid assets were originally acquired for diversification, stability and enhanced risk-adjusted returns when deficits were larger.

However, as funding has strengthened and time horizons have shortened, exits have, in some cases, proven more complex and costly than anticipated.

The paper highlighted several common drivers of exits, including urgent liquidity needs - such as those experienced during the LDI crisis - strategic portfolio reorganisation ahead of settlement, and persistent underperformance.

In situations where an insurance transaction was the target endgame, VLK suggested a range of mitigation strategies to avoid unnecessary value destruction, including early planning to allow more time to disinvest, using deferred premiums or sponsor support mechanisms to bridge gaps, or delaying transactions where economically justified

It also pointed to alternative endgame routes, such as consolidators that may accept illiquid assets and run-on strategies that gave trustees more time to integrate illiquid holdings into a long-term value-generation plan.

Drawing on case studies, the paper outlined how phased reorganisations, in-specie transfers and slow unwinding strategies had, in practice, helped schemes preserve value and manage structural constraints.

The report concluded that while illiquid assets could complicate endgame planning, early preparation, clear governance and disciplined economic assessment could help trustees avoid being locked into suboptimal outcomes as they moved towards settlement.

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