Productive Finance Working Group publishes guides to help pension schemes understand risks and opportunities of investing in illiquid assets

New guides designed to help defined contribution (DC) pension schemes understand the key considerations and risks around investment in less liquid assets has been published today by a pensions industry working group convened by the Bank of England, the Financial Conduct Authority (FCA) and HM Treasury.

‘Investing in Less Liquid Assets: Key Considerations,’ is intended to give DC pension fund trustees, their sponsoring employers and their investment consultants the tools to consider investing in assets such as venture capital, private equity, private credit, real estate, and infrastructure, where appropriate and in scheme members’ best interests.

The Productive Finance Working Group, which produced the guides, is made up of leading industry bodies – including the Alternative Investment Management Association (AIMA), the Association of British Insurers (ABI), the Association of Investment Companies (AIC), the British Private Equity and Venture Capital Association (BVCA), the Investment Association (IA) and the Pensions and Lifetime Savings Association (PLSA) – and around 20 large DC pension schemes, investment managers and consultants.

As UK DC schemes have developed and grown in size, the range of investment opportunities available to them has increased significantly and is likely to increase still further in the years to come. UK DC schemes currently invest relatively little in less liquid assets, compared to UK defined benefit (DB) pension schemes and DC schemes in other countries, such as Australia.

This reflects several factors, one of which is the focus of the UK DC pensions industry across the entire supply chain on keeping costs low. Investing in less liquid assets tends to be more expensive, may take longer to generate value, and some investments may fail to do so.

However, some UK DC schemes are now starting to consider whether and how allocating to less liquid assets as part of a diversified portfolio within a default arrangement could improve member outcomes.

This can be for a variety of reasons including improving the potential risk-adjusted return on member savings, net of costs and charges; reducing risk through greater portfolio diversification; and assisting net zero transition and sustainability objectives.

But like any form of investment, less liquid assets also carry risks that must be managed, and these asset classes may not be a good fit for all schemes. In particular, schemes will need to manage liquidity risk, which they can do by investing in less liquid assets as part of a diversified portfolio, evaluating the schemes’ future cash flows based on scenario analysis and stress testing, and working with fund managers to ensure alignment between liquidity of the fund with that of the underlying assets and understanding a range of liquidity management tools.

The guides published today cover the following key issues related to investment in less liquid assets within default arrangements:

• Value for money: To help shift the focus from minimising cost to a more holistic value assessment, the guide outlines a process for assessing value for members from investing in less liquid assets and provides case studies on how that could work in practice for different types of DC schemes.
• Performance fees: To help DC schemes select, negotiate and co-create performance fee structures that could meet their members’ needs, the guide sets out key principles and maps them to specific features of performance fees to highlight their implications for DC schemes.
• Liquidity management: To support robust liquidity management and give DC scheme decision makers the necessary tools, the guide outlines how DC schemes can meet the liquidity needs of their members, while investing in less liquid assets, by managing liquidity at two levels – the DC scheme and underlying fund levels.
• Fund structures for less liquid assets: To help DC schemes select a route for investing in less liquid assets that meets their specific needs, the guide overviews the key features and considerations around the fund structures potentially available to UK DC schemes.
• Legal guide to the Long Term Asset Fund (LTAF): To help DC scheme decision makers become more familiar with the LTAF as a new fund structure, the guide highlights the key features of the LTAF, including its legal structure and a summary of the key terms.
• Due diligence: To facilitate high standards around investment in less liquid assets, this guide highlights the key considerations around due diligence on the investment managers and products.

To support implementation in practice, within the materials published today, investment and employee-benefit consultants also published a joint commitment to shift the focus from cost to value when advising DC decision makers, and a call to action for DC investment platforms to evolve their processes and systems.

The new publication follows recommendations from the Productive Finance Working Group produced in September 2021 for removing barriers to DC schemes investing in illiquid assets, ‘A Roadmap for Increasing Productive Finance Investment.’

The Productive Finance Working Group comprises: abrdn, the Alternative Investment Management Association, Aon, the Association of British Insurers, the Association of Investment Companies, Aviva, Barnett Waddingham, Blackrock, BNY Mellon, the British Private Equity & Venture Capital Association, BT Pension Scheme, Fidelity International, Hargreaves Lansdown, Isio, Lane Clark & Peacock, Legal & General Group, Macquarie Group, Mercer, NEST Corporation, Partners Group, the Pensions and Lifetime Savings Association, Redington, Rothesay, Simmons & Simmons LLP, TheCityUK, the Investment Association, Universities Superannuation Scheme, Willis Towers Watson and three independent trustees of pension schemes (Steve Delo, Andrew Cheseldine, Ruston Smith). The Steering Committee of the Working Group is co-chaired by the Bank of England, the Financial Conduct Authority, and HM Treasury

Mark Smith, Head of Media Relations
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Steven Kennedy, Senior PR Manager
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