New PPI report backs alternatives for DC investment strategies

The report, entitled “What role could alternative assets play in DC investment strategies in the future?”, was published by the Pensions Policy Institute on March 9.

It explores DC scheme investment in alternative assets, particularly in light of new opportunities and potential benefits that could be gained from using these types of assets during times of economic uncertainty. 

PPI senior policy researcher Lauren Wilkinson said: “Greater engagement with alternative assets could provide DC schemes with enhanced portfolio diversification, which in turn could increase the level of risk mitigation within the investment strategy. 

Changes in policy and regulation, industry and the economy could mean that there is significant progress on alternative investment in the coming years

Lauren Wilkinson, PPI

“This is especially important during periods of economic uncertainty. Many alternative assets have a low correlation with public markets, so are not generally subject to the same market forces, meaning they can provide a hedge against losses experienced during market downturn.”

Broad base of support 

With the implementation of auto-enrolment and the building of scale the main priorities for DC schemes over the past decade, allocation to alternatives has been relatively low.

However, schemes are evolving and many believe that the incorporation of alternatives will satisfy the objectives of value for money and sustainable investment, which are becoming increasingly important to both regulators and members alike. 

The government is also keen to see greater investment in alternatives – particularly illiquid assets – from institutional investors, as part of its broad levelling up project. 

“While this has largely focused on encouraging public sector funds, if DC schemes participate in these markets it will transform the binary passive equity/bond split that has dominated their investment strategies,” Wilkinson said. 

“Changes in policy and regulation, industry and the economy could mean that there is significant progress on alternative investment in the coming years. But some, particularly smaller schemes, may need greater support to overcome barriers.”

These obstacles include: 

• scale, though growth and consolidation in the DC market will reduce this over time;

• knowledge and understanding, with schemes heavily reliant on advisers;

• stronger regulatory guidance; and

• the existing restrictions on charging, though the pensions minister has promised to address this.  

“Alleviating these challenges to facilitate greater alternative investment will require an industry-wide shift in the way that cost and value are evaluated and communicated with stakeholders,” Wilkinson added. 

“This is a key priority for the government, with the value for money consultation ongoing and an overarching aim to shift the discourse away from just low costs and charges towards a greater focus on the quality of service provided and the value added from investments, which may see alternative investments growing among DC schemes.”

All that glisters

Jeremy De Pessemier, asset allocation strategist at the World Gold Council, which partnered with the PPI on the report, said: “The DC investment landscape is rapidly evolving. As DC schemes mature and achieve scale, there is likely to be a growing need for diversifying investments away from traditional equities and bonds into alternatives to deliver good outcomes for scheme members.

We feel that DC strategies can be pushed harder to deliver better retirement outcomes for savers. 

Callum Stewart, Hymans Robertson

“In the current context of economic uncertainty and high inflation, we firmly believe gold can be an effective risk mitigation component within DC investment portfolios. 

“There are several advantages to diversifying the sources of safety in portfolios beyond high-quality government bonds, and the way gold and government bonds perform going forward is likely to be different from one another.”

Make DC work harder

Hymans Robertson head of DC investment Callum Stewart told Pensions Expert: “We feel that DC strategies can be pushed harder to deliver better retirement outcomes for savers. 

“We think that by extending that leash on cost constraints in investment strategies in DC schemes, we can unlock access to, yes, more expensive building blocks, but building blocks or asset classes that draw long-term returns perspective – interesting from a diversification perspective, and certainly interesting from a kind of wider sustainability perspective as well.”