This article, authored by myself and Melville Rodrigues, Head of Real Estate Advisory at Apex Group and a trustee of the Social Market Foundation, first appeared in the Times on 1st June 2022: https://www.thetimes.co.uk/article/a2837398-e11c-11ec-8bdd-c253e043f5f0?shareToken=7c149d7bed220b437aee148d85490b70
With the demise of final-salary defined benefit pensions, more and more people will rely on defined contribution (DC) schemes in retirement. That makes it all the more vital that returns on the wealth held in them are maximized.
But the status quo is not delivering the best outcomes for DC pension holders. A key reason is that, compared with their peers overseas, UK pension funds lag behind in investing in “illiquid” assets such as real estate, infrastructure, private equity and venture capital.
The seven largest pension markets globally allocate on average 19% to illiquid assets - up from 7% in 2000. However, UK pension allocation has remained flat at about 7-8%.
If past performance is anything to go by, UK pension holders are missing out as a result of this. Some estimates suggest that a 22 year-old new entrant to a default DC scheme with a 5% allocation to venture capital/growth equity could achieve a 7%-12% increase in total retirement savings.
Further, if pension funds were to invest more in infrastructure, billions of pounds could be unleashed to help “level up” struggling parts of the economy. Pension wealth can also be channeled more directly into green investments, helping us to reach Net Zero faster.
Desire for such a “social return” is now a mainstream interest: Aviva has found that 72% of UK pension savers say they consider environmental, social and governance (ESG) factors important when investing.
The Bank of England, the Financial Conduct Authority (FCA), HM Treasury and the asset management sector have started to rise to this challenge, collaborating via the Productive Finance Working Group (PFWG) to address this challenge.
Building on this collaboration, “Long-Term Asset Fund” (LTAF) regulation took effect in November. The LTAF rules allow managers to adopt a strategy of investing mostly in long-term, illiquid assets.
Investors must accept a 90-day notice period, giving an LTAF time to sell assets in an orderly way – helping to avoid any repeat of the problem faced by funds investing in real estate following the 2016 EU referendum. Then, some investors wanted to get their money back quickly. But selling quickly at low prices – operating under “daily dealing” rules – hurt investors who wanted to keep their money in the fund.
Now that sensible regulation is in place, LTAFs should be attractive to pension schemes. But as yet, no LTAFs have been launched. Why are UK savers being denied the greater financial and social returns that they desire?
The answer lies partly with our low-cost investment culture: managers distribute DC pension products via investment platforms – “fund supermarkets” which minimise operating costs for customers.
Minimising costs is commendable, but there are consequences. The platforms’ infrastructure caters for liquid, daily-dealing financial products such as equities. The processes developed by the low-cost platforms simply cannot contain illiquid investments, meaning LTAFs cannot be added to the typical pension portfolio.
Platforms need to update their legacy infrastructure to handle LTAFs. We are aware of several fund managers that are keen to launch LTAFs as soon as this barrier is removed.
The answer is more collaboration within the asset management sector , under a principle of “beneficiary pays proportionately”. Everyone who earns fees from LTAFs – platforms, asset managers and service providers – has an interest in overcoming the barriers, and so should contribute.
This issue is even more relevant given the FCA’s new Consumer Duty, expected to be announced in July and implemented next year . This duty will push financial services firms to focus more on good customer outcomes. This should mean the asset management sector doing more to help pension-holders maximise their returns – by making it easier to invest in illiquid assets.
Happier retirements. A more balanced economy. A faster transition to Net Zero. These are the prizes that pension fund investment in illiquid assets could bring. The barriers that stand in the way – in particular those stopping platforms onboarding LTAFs – must be overcome.
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