Aon head of DC investment advisory Chris Inman explores the many uses of illiquid assets in pension portfolios.
DC members face an uncertain outlook. ‘Late cycle' worries keep coming back, bringing with them bouts of market volatility, as we saw at the back end of 2018. Amid this uncertainty, there are untapped opportunities. The increasing access to illiquid assets that broaden the investment opportunity set for DC schemes, as well as the potential for responsible investing initiatives to engage savers, will be key to improving member outcomes. Both can be utilised, along with the current DC investment range, in individualised glidepaths, which explicitly target the member's desired outcome.
Why is DC investment in illiquid assets set to increase?
There has been a lot of focus on illiquid assets as the solution to all our problems. While we do believe that their use can help improve member outcomes, we should fundamentally be considering them as a diversification tool, offering wider access to markets and benefits through a number of factors, including lower correlation to equity markets; inflation linked returns; and illiquidity premium. Given the long-term nature of DC savings, illiquid assets are a natural fit but they are not a homogenous group!
We see their potential usage differing according to DC savers' varying objectives, for example:
• Explicit inflation-link may be achieved through contractual terms within many infrastructure projects, supporting real long-term growth;
• The relatively high expected return potential through private equity or venture capital portfolios (versus public equity) may particularly benefit members in the ‘early career' stage, who typically have a higher risk tolerance and the opportunity to seek higher returns through taking on illiquidity risk;
• Superior downside protection compared to many listed exposures, particularly during times of market stress; and
• A natural income yield, which has potential to form a significant part of an investor's spending needs post-retirement.
Aon believes illiquid assets have a big role to play in DC default funds. We currently create bespoke, outcome-oriented strategies, either standalone or as part of fiduciary solutions, that combine illiquid assets with listed alternatives for liquidity, diversification and tactical asset allocation purposes.
Click here to learn more from Aon on how to improve member outcomes for DC pensioners