Illiquid assets: Latest fad or the future of DC investment?

DC savers tend to have a long investment horizon, in theory making it possible to lock some money up for a higher return. Yet in the UK, where the vast majority of DC savers are in default strategies, these generally do not include illiquids, or only a small part through diversified growth funds.

The well-established practice of daily pricing in DC is often cited as an obstacle.

And while property, also illiquid, is frequently offered as a self-select option in DC, it tends to be more correlated to stock markets through extensive use of listed vehicles.

But Laura Myers, partner at consultancy LCP, says there are moves underway to come up with a daily price for illiquid assets.

“That wouldn’t actually mean daily trading; we would use illiquid assets alongside liquid things like equities,” she says, adding that such a combination could be used for younger members in a default fund.

“Say you had 10 per cent to 15 per cent of the fund illiquid with the rest liquid, as members move in and out that proportion would move up and down slowly, and then if you needed to rebalance you would do that at the quarterly or monthly liquidity point,” she explains.

How to get a daily price

A key issue in the debate is what to use to provide a daily price.

Myers says it would be up to trustees to decide how to price in-between trading points. They could ‘stale-price’ – providing a price which is not up to date – or base it on yields, “[as] property funds do when they use the rental income to create the price”.

In essence, there would have to be a proxy price with the fund taking any pricing difference, she says. This throws up questions of equitable treatment of members, “which is why I think a lot of DC schemes are struggling with the idea at the moment and not many people are implementing it”.

One market where DC schemes tend to use illiquids is Australia. Superannuation fund Primesuper’s default option, for example, allocates 13 per cent to infrastructure as well as holding private equity.

The super’s illiquid assets are revalued on a six-monthly basis and priced monthly using capital and income movements. Under this model, members see a small upward trend in the first five months of the half-year period, with the sixth month showing the effect of any revaluation.

This absence of daily unit pricing is deliberate, says chief executive Lachlan Baird. “My view is that, particularly during the accumulation phase, investing is for the long term and daily pricing is not conducive to members investing for the long term, as it allows for short-term thinking.”

Baird says the super spent some time considering the use of cash return or index return to apply a monthly value, but concluded that it would still lead to an adjustment at the revaluation date.

“Whatever is used it will not be the actual return, as such there will always be a peak at the time a valuation occurs,” he says, stressing that this problem remains the same if pricing happens daily.

Systems and regulations

Daily pricing is not mandatory, but UK best practice means platform providers have to move investments within just a few days. Accordingly, systems have been designed along those lines.

For David Hutchins, senior vice-president and lead portfolio manager multi-asset solutions EMEA at AB, the current architecture for DC investment is out of date, offering daily dealing when it is not used by the majority of DC savers.

“We built something which was a retail investment proposition… for engaged investors who want to trade between funds every day,” he says. “Where everybody is in the default strategy, you just don’t need it.”

Anne Swift, director and head of DC investment at consultancy KPMG, also singles out platform providers. “It’s more a systems issue. Everything is automated,” she says, questioning whether there is any appetite among providers to change this.

Hugh Skinner, director at platform provider Fidelity International, agrees systems cannot be changed overnight, noting that regulatory requirements for platform providers have resulted in the current environment.

“You have to make sure that people can leave the scheme in a certain amount of time,” he says.

Skinner warns that providing a price between trading points could have repercussions if that price is not accurate. “Who wants to take on responsibility of providing an inaccurate price that has to be unit-linked?”

Despite this concern, he concedes that “there are some [funds] that need to be looked at”.

One recently launched fund for DC investors is Partners Group’s Generation Fund. Joanna Asfour, senior vice-president at the private equity house, says the creation of a UK-regulated fund “really was driven by platform providers”.

The company has to come up with a daily price for all the fund’s underlying market content. “I think what’s deterring other pure private equity players is the backbone to look through the portfolio, every single deal, and come up with a daily price for that,” says Asfour.

Who will move first?

The question of who can access illiquid funds lies partly in the hands of platform providers, which need to decide if they will offer such funds, and partly with schemes.

Myers says it will be mainly large, unbundled schemes that will invest, as, “where they pay for administration costs, costs are pressured even more, so it would be very difficult for them to access these more expensive illiquid assets”.

Swift says the use of illiquids in DC will depend on fund sizes. “Scale is going to be everything, but it needs to be scalable at the bottom level.”