U.K. government consults on incorporating illiquid assets in DC investments
BY Yaelle Gang | February 20, 2019
A consultation paper by the U.K. government is considering how defined contribution plans could incorporate more illiquid investments.
Specifically, the consultation’s proposals include requiring larger DC plans to set out their policy and current practice for illiquid investments and report on it annually. It also proposed requiring smaller DC plans to conduct a triennial assessment of whether their members would receive better value if consolidated into a larger plan.
“This will improve governance, and enable more pension schemes to reach the critical mass needed to access a broader range of investments, and nudge them to consider the benefits these investments offer,” said Guy Opperman, U.K. minister for pensions and financial inclusion, in the foreword to the consultation.
The consultation, which is open until April 1, 2019, also proposed offering an additional method of assessment for compliance with the charge cap for default funds used by auto-enrolment pension schemes to accommodate performance fees.
Last week, U.K.-based JLT Employee Benefits released a paper, which found a 20 per cent allocation to illiquid alternatives could increase the anticipated size of a DC member’s default pot at retirement by around 10 per cent net of fees.
Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits, says U.K. DC plans aren’t generally investing in illiquid assets at all. “There’s no real sophisticated investment strategies, but particularly they’re not using any alternatives or illiquids really. There may be a very small minority that might use some listed alternatives, or maybe listed property like real estate investment trusts, that kind of stuff, but overwhelmingly they just do not invest in illiquids.”
She attributes this largely to the fact the U.K.’s DC market is relatively young. “We have had DC for a while, but it was only tiny, so mostly we were a land of DB. And DB plans obviously invest in illiquids and all sorts of investments, and when DC started to come through it was all just unit-linked, daily-dealt pooled funds.”
The U.K.’s auto-enrolment legislation has been in place since 2012 and the money in DC plans is rapidly increasing, says Nazarova-Doyle, though she notes the way plans invest hasn’t changed. “Obviously, the landscape of DC has changed massively over several years, but the way they invest is still the same and very basic.”
Dany Pineault, principal on the DC consulting team at Morneau Shepell Ltd., points to differences between the Canadian and U.K. DC systems as the reason a consultation like this one wouldn’t be as relevant in Canada.
For example, most Canadian DC plan sponsors offer investment choices through a provider and the market is held by mostly a few large insurers. So, the individual plans have more flexibility to access investments on a larger scale through these insurance providers than they would if they were managing investments individually because the providers can meet minimum size requirements, Pineault explains. “So then on the insurance company level, we have the size and the leverage to be able to provide those kind of funds.”
Though the U.K. has several large record-keeping platforms, there are also thousands of employers running their own single-employer DC plans, says Nazarova-Doyle. “They’ll have a trustee board that will run the investments and the DC scheme for that particular employer. And it’s very fragmented, so we have thousands of them, and they generally tend to be quite small.”
Zaheed Jiwani, principal and head of DC consulting at Eckler Ltd., says illiquid investments in Canadian DC plans aren’t as prevalent as they could be. He suggests elements of the consultation paper could resonate in the Canadian market.
In terms of the ways DC plans currently incorporate illiquids in Canada, Jiwani explains many have done so through standalone funds or as part of a multi-asset class portfolio — for example, through a balanced fund, target-risk fund or target-date fund.
However, offering illiquid investment choices can be challenging because most DC plans, through their record-keeping arrangements, must have daily liquidity and valuation, he says. “It limits the universe of illiquids that you offer because illiquids, by their nature, aren’t traded daily and most aren’t valued daily.”
Some standalone funds will have illiquid assets, but underneath the surface they contain other liquid assets that are valued daily to provide a daily value and liquidity, says Jiwani.
Currently, the simplest way to implement illiquid investments in DC plans in Canada is offering a single balance fund, he adds. “That would be the easiest way to implement illiquids because it’s running similar to a defined benefit plan, in that the members don’t have choice, there’s just one investment option and the asset mix decision is controlled by the pension committee, and the pension committee decides how much they want to allocate to illiquids and then you have someone managing the investments to make sure that the cashflows are managed accordingly.”
Also, some single balanced funds don’t require the daily valuation and daily liquidity on non-traditional platforms because members aren’t trading in and out, says Jiwani.
“For those that are on traditional platforms or that need daily valuation and daily liquidity, the overall multi-asset class fund or funds can still have it . . . . You can still strike a daily valuation because the majority of your other assets are getting valued daily and it’s just a portion that isn’t being valued daily.”
One element of the U.K. consultation that could be relevant in a Canadian context is the idea of having a policy regarding illiquidity, says Jiwani, noting it could be beneficial to require DC plans to develop an investment philosophy and, within that, a policy on illiquids. “The reality is you have an extremely small percentage of plans that are investing in illiquids right now. I think if you have that requirement it will make plans wake up and say, ‘Wait, what is our policy? We’ve never really looked at that, so we should think about it.’”
Plan sponsors looking to increase their DC plan’s allocation to illiquid assets should seek advice from someone who has done it before, as illiquids in DC are a different animal than in DB plans, says Jiwani. “Not only do they need someone that has experience in illiquids. Not only do they need someone that has experience in DC plans. They need people that have experience in both, because we’ve seen a lot of people go down this route and not getting that full advice that overlaps between DC and illiquids.”
Nazarova-Doyle says she hopes the U.K. pension industry will get behind the latest consultation. “The problem is that nobody’s really talking about it or thinking about it, and I’ll just be happy to see a healthy level of debate from it. And hopefully, we’ll move on to make DC able to invest in a wide variety of illiquid alternatives as well, because I actually do believe that it will benefit members in the long run.”
She also highlights that people aren’t saving enough for retirement. But just like people need to save more, it’s also important for investment strategies to deliver more. “I think this kind of investment goes a long way to support people in bridging that retirement funding gap.”
Updated: 1:40 p.m. February 20, 2019.