Rebekah Brady explores the little known area of illiquid assets and how they can be applied within a pension scheme.
As we face into a world of lower expected returns from practically all of our asset classes many practitioners are looking for alternative or new sources of returns to help people get their retirement savings working for them. One alternative source of returns, which investors have been using for many years within defined benefit schemes, are illiquid assets. Many of us are familiar with liquid assets, i.e.an asset that can be easily converted into cash. Illiquid assets are different, these are assets that cannot be readily sold, like property. But how can illiquid assets work within a pension scheme, specifically that of Defined Contribution (DC) schemes? And how would the administration of that work?
At Acuvest, we have been working with our DC clients in the area of investment management to introduce illiquid assets for many years now into their default funds.
Daily Trading & Illiquid Assets
The original hurdle that most schemes faced was squaring the circle of allowing members trade daily into and out of a fund which held some illiquid assets.
What many trustees realised was that the vast majority of their members were seldom, if ever, switching their fund choices within the DC Scheme. And the small minority who were switching frequently, would be financially better off if they switched less. This informed some groups of trustees that they could move from daily to less frequent switching, often monthly.
Many DC Schemes are also relatively young (in that they don’t have many members at or even close to retirement). This means their default fund is usually significantly cash flow positive (which again helps alleviates concerns around liquidity issues), i.e. there is significant cash flowing into the default fund which more than covers any switching requests from members to move out of the default fund. Illiquid assets are unlikely to constitute more than 25% of a default fund, and likely to build up slowly, allowing the scheme and administrator to adjust gradually to the new process.
What about our Administrator?
Trustees need to be confident that their retirement savings and pension scheme management will always be administered correctly, however, administration should not be the driving force when determining investment strategies. There are administration systems that are capable of dealing with illiquid assets – the trustees simply need to agree a pricing strategy that will be fair to all members. Talk to your independent investment adviser and get their help in discussions with administrators.
Just because your scheme is capable of holding illiquid assets, it does not necessarily mean you should.
Yet this often untapped pairing of illiquid assets and DC schemes should be given some consideration. For all the negative connotations surrounding illiquid assets – primarily, the lack of a quick fix conversion to cash – they can have a place within DC schemes where members are invested for the long term.
As with any investment decision it is important for the Trustee Board, in consultation with their investment adviser to thoroughly review the merits of any investment opportunity, illiquid or otherwise and focus on the expected impact on member outcomes.
Rebekah Brady is Head of Investments and Research at Acuvest, focusing on investment research and client management. Contact Rebekah at firstname.lastname@example.org
Acuvest is an independent pensions and advisory management business taking care of the futures of over 40,000 of our clients’ employees. For more market analysis and expertise follow Acuvest’s daily updates on Twitter @AcuvestIreland and LinkedIn and our fortnightly blogs.