Pension funds will have access to a Long-Term Asset Fund regime following changes made by the Financial Conduct Authority, with special flexibility afforded to defined contribution schemes to invest in illiquid assets.
The FCA said on Monday that the new type of open-ended investment fund will “help support investment in assets like infrastructure and private equity”, and that investment in these assets has the “potential to generate better returns for investors, including those saving for retirement in DC pension schemes”.
The new LTAF regime, which will come into force on November 15, came about in response to investor hesitancy and inability to invest in long-term illiquid assets, and to overcome the DC market’s “failure” in not being able to make this type of investment.
Nikhil Rathi, chief executive of the FCA, said: “We are supporting fresh collaborative thinking designed to improve the effectiveness of UK markets while protecting standards.
For this to succeed investors need to be very clear on what they are invested in, what they are paying, and what their rights are when it comes to issues such as redemptions and dealing
Helen Morrissey, Hargreaves Lansdown
“If this innovative fund structure, created by our rules, is taken up by the asset management industry, it may provide alternative routes to returns for investors, while supporting economic growth and the transition to a low carbon economy.”
He added that the LTAF is aimed at DC pension schemes “which may be interested in investing, in line with their investment horizons and risk appetite”.
90-day minimum redemption period
Under the new rules, the investment strategy of an LTAF must be to invest mainly in long-term illiquid assets, with at least 50 per cent of the assets being unlisted securities or other long-term assets.
The FCA is also set to introduce a rule that will require an LTAF to redeem units “no more than monthly”.
Given the nature of investments LTAFs are likely to hold, the regulator said that the maximum redemption frequency is “appropriate” for an LTAF as it ensures that daily dealing is excluded within the policy.
The FCA will also add a rule requiring an LTAF to have a notice period for redemptions of at least 90 days, although it said that it expects many LTAFs to have notice periods “significantly longer” than this.
Rathi said: “As investments in this type of fund may take longer to sell, the FCA has put in place rules to ensure there is a consistency between how long it will take to sell assets and how often and quickly an investor will be able to sell out of the fund.”
Removal of illiquids cap goes ahead
Proposals to remove the illiquids investment cap, currently at 35 per cent, are to go ahead following widespread calls from the industry, the policy statement said.
The FCA said that the amendment to the cap will “enable more flexibility in the construction of DC scheme portfolios while maintaining an adequate level of protection for DC default scheme investors”, and that current proposals provide a “sound and workable starting point for initial use of the LTAF in unit-linked structures while enabling an appropriate level of protection for DC default investors”.
As initially proposed, investment in LTAFs via unit-linked funds would only apply for default arrangements in occupational or workplace pensions, and will not be available for self-select options available to members or for non-workplace personal pensions.
On disclosure rules, the FCA said that it views these as an important tool to “enable potential investors in LTAFs to understand the fund that they are investing in”, and has encouraged managers to produce materials that are written in a way that is “appropriate to the audience”.
It has also said that it supports the work of the Cost Transparency Initiative and would welcome LTAFs “disclosing consistently” with the CTI’s templates, although it will not be required.
Managers of LTAFs, where they have investors who use the CTI, have been encouraged to provide the relevant information to those members. The FCA also said that it “expects” managers of LTAFs to explain how their performance fees work, so that “investors can make a judgment about the merits of investing in a fund”.
Callum Stewart, head of DC investment at Hymans Robertson, said he is “supportive” of the FCA’s proposals to extend the range of vehicles for pension schemes to access long-term investments such as illiquids.
He added that he shares the FCA’s “positive view on work” carried out by the CTI, and that this should be used in the context of LTAFs where at all possible.
“As always, however, we should consider member needs first. This development should support greater product innovation and choice for DC schemes, and ultimately improve outcomes for members. Member security and the transparency of costs and charges are also important considerations,” he said.
Industry welcomes regulatory regime
Steven Cameron, pensions director at Aegon, said the move will create a “new route towards greater investment in long-term illiquid assets”.
“LTAFs are a key stage in the critical path towards DC pensions investing more in illiquids. Trustees and scheme managers may choose this approach to access illiquid investments, investing a small proportion of scheme default funds in these, rather than in individual long-term projects,” he said.
“This will allow them to achieve greater diversification and a spreading of risk within this form of investment, while also drawing on the expertise of the LTAF manager in this specialist area.”
But he added that it is “unlikely” the industry will see an overnight transformation or rush.
BoE sets out illiquids ‘roadmap’ but doubts remain
CPD: Despite a detailed report from the Bank of England suggesting a roadmap for DC schemes to invest in illiquid investments, industry professionals and members have doubts about the practical implications of these allocations, writes Benjamin Mercer.
“Members of DC pension schemes now fully expect their pension funds to be priced daily and to be able to switch funds, transfer between schemes, or from age 55 access their pensions flexibly, all without any delay or notice period,” Cameron continued.
“LTAFs will have notice periods of various lengths and the underlying assets won’t have daily prices with redemptions no more frequently than monthly.”
Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, noted that investing in illiquid assets “offers a huge opportunity for investors to boost their pension pots by investing in areas such as private equity and infrastructure”.
“However, for this to succeed investors need to be very clear on what they are invested in, what they are paying, and what their rights are when it comes to issues such as redemptions and dealing. Getting this right is vital to building confidence in LTAFs and making them a mainstream part of the DC landscape in the future,” she said.
