Alternative assets could boost pensions by 10%

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Alternative assets could boost pensions by 10%

An allocation to professionally managed illiquid assets could boost defined contribution (DC) pensions by 10 per cent at retirement, according to JLT Employee Benefits.

The firm suggested a 20 per cent exposure to illiquid assets such as private equity, infrastructure or real estate, could enhance diversification and generate additional return. 

The comments come after the Department for Work and Pensions issued a consultation on how to direct some of the £60bn held in defined contribution pension schemes into alternative illiquid investments to boost the UK economy. 

The consultation followed the announcement in the last Budget that the Chancellor was to allow DC schemes to invest in British businesses under the patient capital initiative.

Analysis by JLT Employee Benefits found those in DC default funds have a much lower need for liquidity as a result of the long time horizons to retirement. 

Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits, said: "The focus on daily-dealt funds with near 100 per cent liquidity is a fundamentally impatient approach to DC.

"Many default strategies are currently failing to adequately diversify investments, precluding savers from the valuable illiquidity premium that can be accessed through alternatives.

"The pensions industry and the government have recognised that current short-termism is misaligned with the long-term horizons of DC savers, but it is now time for decision-makers to work collaboratively and take action to bring the benefits of illiquid alternatives to DC defaults."

However, the firm also stated that manager selection remained critical because of the large dispersion of returns within the alternatives space, as well as liquid alternatives being hard to value in certain market conditions. 

Martin Bamford, chartered financial planner at Informed Choice, said: "When carefully selected and managed, allocating part of a pension portfolio to non-traditional investment assets can help to improve diversification, lower overall risk and boost returns. 

"The trouble is these alternative assets tend to be illiquid and riskier when viewed in isolation, often making them unsuitable for individual investors.

"We see college endowment, sovereign wealth and corporate pension funds use them with some success. Getting access to the best opportunities in infrastructure investment, which are often reserved for government money, is the biggest challenge."

Adrian Lowcock, head of personal investing at Willis Owen, added: "Alternatives such as private equity, infrastructure and real estate are under-utilised investments because they require a long term investment timescale and a lot of patience – with a lack of liquidity being a deterrent.

"However they offer huge diversification benefits as they tend to not be as correlated to equites and bonds which can help deliver a better return for investors.   

"Of course with all of these calculations it is a case of averages (it is hard to predict the future accurately), but it isn’t the return itself investors should consider but the risk they are taking to achieve the returns. Exposure to alternatives will help reduce risk of a portfolio and around 20 per cent in such areas can add a lot of value to a portfolio."

Mr Lowcock said illiquidity was a fundamental issue but he added pension funds were ideally placed to invest in such assets.

"The fact is for their investment time horizons they don’t need to be concerned about liquidity as long as they don’t have too much in illiquid investments and can meet the demands of the beneficiaries," he said.

JLT Employee Benefits is now calling for remaining technical challenges to be addressed, such as launching pooled vehicles to ensure optimal diversification and the process of managing scheme events like death before retirement or pension transfers, which would require early encashment. 

Also under the microscope are the high fees that typically come with illiquid asset investments. According to JLT Employee Benefits, it would be difficult to meet a 0.75 per cent charge cap. 

The Financial Conduct Authority is currently consulting on the regulations that force liquidity for unit-linked insurance contracts and retail investment funds. 

JLT Employee Benefits has suggested these were designed for different classes of investor with much higher liquidity needs than long term DC default savers. 

Ms Nazarova-Doyle said: "If savers can’t access their money for 20 years or more, why should they be forced to invest ‘impatiently’ in daily-dealt funds? 

"With a generation of DC savers facing inadequate income in retirement, the pension industry must collaborate with government and alternative investors to create the new solutions that can drive better investment returns and risk management and ultimately a better retirement for all."

Laith Khalaf, senior analyst at Hargreaves Lansdown, said: "There may be rewards on offer from illiquid assets, but this is an area where it’s hard to demonstrate value as a fund manager compared to more traditional assets with more obvious benchmarks for comparison.

"In addition the costs can be higher and so more difficult to fit within the auto-enrolment price cap. 

"Overall most default funds probably don’t allocate enough to equities for many of their investors who have more than 10 years to retirement, and advisers, providers and employers would do well by members to help them invest outside the default and into a strategy which is more appropriate to their circumstances."