Industry bodies to 'develop the case' for DC illiquid investments

A meeting of the Bank of England’s Productive Finance Working Group held on July 28, the minutes of which were published on August 20, discussed a variety of ways to encourage greater investment in long-term, less-liquid assets, which the working group’s draft report said would bring benefits both for pension savers and the wider economy.

The meeting heard that, though ensuring costs are low has been a vital part of the growth of DC, “an excessive focus on cost alone” as the sector matures “could become a missed opportunity to secure long-term value for members in the future”, according to the minutes.

Some members of the group — which includes representatives from across the industry, such as Aviva, BlackRock, HSBC, Legal & General and Nest — warned that the industry must do more “to make a positive case to schemes that investing in less liquid assets may be in their members’ interests and that the risks can be managed”.

Alongside support for trustees managing liquidity at the DC scheme level, they would also need a range of products that provide access to less liquid investments

Productive Finance Working Group

Though recognising that some investments and less-liquid asset classes might not be appropriate for all schemes, the The Pensions and Lifetime Savings Association, Investment Association and the Association of British Insurers, along with TheCityUK, “agreed to develop the case for schemes to invest in less liquid assets”, the minutes noted.

Regulatory changes

Opinion among the members was split as to whether and how much regulatory intervention was required to shift the focus from costs, which some participants said was “entrenched”.

One option considered was that pension schemes be required to actively consider such investments and, if they choose not to, explain why; though the minutes recorded that “there was no consensus on this, as other members thought that it should not be the role of government or regulators to direct investments — in particular asset classes — and were concerned that this would further increase the administrative burden on pension schemes”.

The working group as a whole welcomed the recent move by the Department for Work and Pensions to introduce “smoothing” into the charge cap, though some members said this did not go far enough, and advocated excluding performance fees from the cap where they were associated with greater long-term value for members.

“One member expressed scepticism about the value and necessity of such fees at all and thought the solution was for asset managers, consultants and DC schemes to work together to develop innovative and flexible methodologies for performance fees that are better suited to DC schemes,” the minutes showed.

Though no consensus on either proposal was reached, the group’s steering committee agreed “to continue to develop recommendations on them with the aim of gaining greater support”.

FCA to consult on illiquid investment rules

The proliferation of small schemes in the DC sector hinders the push towards less-liquid and illiquid asset classes, the group heard, not least because small schemes tend to lack the bargaining power to negotiate fees, or the expertise to make complex investment decisions.

The two leading proposals to tackle this problem include consolidation, which the DWP is already pushing for and that the working group supports, and to make less-liquid asset classes more accessible to smaller schemes.

“A wider range of fund structures can support pooling of multiple assets into a single fund vehicle,” the minutes noted, adding that HM Treasury’s new Long-Term Assets Fund “will be important in supporting this”.

“To facilitate the distribution of less liquid assets, including the LTAF, to a broader range of investors including DC schemes and retail... there was broad support for the [Financial Conduct Authority] to consult on changing their rules for investment in less liquid assets through unit-linked funds and review their rules for distribution to appropriate retail clients, respectively,” the minutes continued.

FCA chief executive Nikhil Rathi told the meeting that the FCA “would take these forward to consultation”.

One working group member did sound a note of caution about the LTAF, however, warning that it should not be made available to retail investors until “it had demonstrated that it was safe in the institutional market in both good and bad market conditions”.

Liquidity management is still an issue

The meeting also discussed approaches to liquidity management, noting that robust processes are particularly important given that many less-liquid and illiquid asset classes cannot be bought and sold on a daily basis.

“Alongside support for trustees managing liquidity at the DC scheme level, they would also need a range of products that provide access to less liquid investments,” the meeting heard.

“In addition to existing opportunities, [the working group] has further developed the key elements of the LTAF, which is specifically designed for investment in less liquid assets, and requires aligning redemption policy of the fund with liquidity of its assets.”

Group members expressed “broad support” for industry and trade bodies “to develop guidance on good practice on liquidity management at a fund level, in collaboration with the FCA and the Bank of England”, the minutes stated.

However, the industry’s current reliance on daily dealing will require a “mindset shift”, making it “vital that the new liquidity toolkit was transparent, flexible, effective in bad times, as well as good, and investors had full confidence in and understanding of them”.

The IA was joined by the British Private Equity and Venture Capital Association, and Abrdn, in pledging to develop the liquidity toolkit and associated guidance.