Value over cost, emphasizes in new guides to illiquid DC investing – law and regulation

In March, the government opened a consultation on facilitating DC investments in illiquid companies. DC investments in illiquids are minimal in the UK compared to countries like Australia.

In October, the Department of Works and Pensions confirmed that it would press ahead with requiring trustees to include a policy on illiquid investments in the statement of the chairman of their DC schemes, despite industry criticism. DC systems of all sizes will be subject to the new regulations.

The Productive Finance Working Group, convened by the Bank of England, HM Treasury and the Financial Conduct Authority, published a series of guides on November 24 to help fiduciaries better understand investing in illiquid assets.

“Both the quality and the cost of the investment strategy could be given more weight in the decision-making process,” it said.

The group warned that fees were too regularly used as a “proxy for value”, with investment decisions based on “a handful of basis points”.

It acknowledged that investments in less liquid assets tend to be more expensive and take time to generate value, with some investments delivering no value at all.

However, the group suggested that the usual time horizons for evaluating investment returns in DC – which measure returns over quarters, one, three and five years – would be inappropriate for illiquid companies.

“For employers selecting a pension provider for their employees, shifting the focus to value means choosing approaches that are expected to deliver good pension outcomes that are also not necessarily the cheapest option,” the group said.

“Be prepared to increase fees for members when an allocation to less liquid assets increases the chance of improving retirement outcomes for their members, and recognize that long-term allocations to less liquid assets take time to build.” will,” she advised.

The guides also provide an overview of fund structures that can provide DC systems with access to illiquid funds, liquidity management and illiquid fund performance fees.

“We expect this to further accelerate the investment case and demand for illiquid forward-looking DC trustees,” said Mark Calnan, Willis Towers Watson’s head of investments for Europe.

“Particularly for defined contribution schemes and their often younger members, a long-term approach to asset allocation requires a role for illiquid companies within a balanced portfolio.”

Lee Hollingworth, head of Franklin Templeton’s UK retirements, said many DC programs will be valuing illiquid right now.

“Private markets have a lot to offer investors to help them navigate difficult economic conditions such as high inflation and the low-growth environment,” he said.

“You can also support a program’s sustainable investment goals through direct investments in areas such as energy transition, social infrastructure (e.g., building healthcare, education and affordable housing), and natural capital.”

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