Pensions - Articles - Illiquid alternatives could increase DC pensions ten percent

UK defined contribution (“DC”) pension savers could enjoy a 10% boost to their pension pots at retirement through the addition of an allocation to illiquid alternatives to default strategies, according to new analysis by JLT Employee Benefits.

 Many DC default funds are rapidly becoming larger, have a very long time horizon to retirement and are receiving material cash inflows. They therefore have much lower need for liquidity than almost any other type of investor. However due to a combination of history and regulation they predominantly invest in daily-dealt public markets, which provide daily liquidity, but preclude DC savers from accessing illiquid alternative asset classes. 

 Exposure to illiquid assets such as private equity, infrastructure and real estate, with low or negative levels of correlation to traditional assets, can enhance diversification and generate additional return through an illiquidity premium. These benefits do come at the cost of several important risks:

 • Some individual illiquid alternatives can have high “failure” rates, though with proper diversification and some smoothing of valuations the measured volatility can appear relatively low compared to listed investments.
 • The large dispersion of returns between investment managers across the alternatives space means that manager selection is a critical component of the incorporation of illiquid alternatives within DC defaults.
 • And last but not least illiquid alternatives are illiquid and can be hard to value in certain market conditions.

 To ensure that there are robust solutions available in future, for the DC default schemes that can benefit from them, the following technical challenges need to be addressed:
 • Regulations that force liquidity for unit linked insurance contracts and retail investment funds to be designed for different classes of investor with much higher liquidity needs than long term DC default savers. The FCA is currently consulting on this.
 • Pooled vehicles need to be launched to ensure that optimal diversification can be achieved. Legal and tax restrictions on the investment structures used by alternative investments need to develop to be fit for purpose.
 • Due to the bespoke nature of many of these investments they tend to have relatively high fees, so for a meaningful allocation it may be difficult to meet a charge cap of 0.75%.
 • The stakeholders and advisers of DC default schemes need to be educated in the benefits and risks of illiquid alternatives and to upgrade their mind-set accordingly.
 • Consideration on how to manage scheme events such as Death before retirement or pension transfers which will require early encashment.

 Maria Nazarova-Doyle, Head of DC Investment Consulting, JLT Employee Benefits, said: “The focus on daily-dealt funds with near 100% 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.”

 To illustrate the difference that long-term investment in alternative assets can make to members’ pension outcomes, JLT Employee Benefits called on the help of Max, an example of a young DC saver at the start of his working life.

 Max is 22 years old and has just been auto-enrolled into his employer’s pension scheme. He earns a UK average salary of £29,588 which increases in line with inflation and his total contributions are set at 8% (minimum AE level from April 2019). He has no starting savings.

 Below are the results that he could expect by the age of 57 using estimates of net long-term market returns provided by JLT’s Market Forecast Group for Listed Equities (LE), Private Equity (PE) and Infrastructure Equity (IE), for illustrative purposes.

 Our results show that Max could increase his pot at the age of 57 by around 12% if an allocation is made to diversified illiquid private equity compared to listed equities alone, after all fees and using median manager returns. A more diversified portfolio would be expected to still provide 8% over and above what traditional daily dealt equities could be expected to deliver for Max.

 On average, member pots could be boosted by c. 10% through the addition of some illiquid assets to the default strategy early on. Generally speaking, the earlier in the savings stage illiquid investments are added and the higher the contributions that members pay in, the better the results will be from these investments, compounded over many years.

 Maria Nazarova-Doyle, Head of DC Investment Consulting, JLT Employee Benefits, 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.”

Back to Index

Similar News to this Story

Sackers launch guide for trustees on pension transcations
Sackers have published its latest guide for trustees on buy-ins, buy-outs and longevity transactions. This guide is focused on supporting pension sche
Pensions Minister echoes climate warnings in Westminster
MPs from across the House of Commons have debated climate change and pensions. Pensions Minister Guy Opperman responded. Earlier he spoke of ‘kickstar
New tools allow pension schemes to deliver greater value
New tools helping pension schemes deliver greater value for money for millions of savers have been launched today (21 May) by the Cost Transparency In

Site Search

Exact   Any  

Latest Actuarial Jobs

Actuarial Login

 Jobseeker    Client
Reminder Logon

APA Sponsors

Actuarial Jobs & News Feeds

Jobs RSS News RSS


Be the first to contribute to our definitive actuarial reference forum. Built by actuaries for actuaries.