Natixis' white paper A Fetish for Liquidity , gives a comprehensive view of how UK DC schemes view the benefits and pitfalls of investing in private markets.
In your new white paper "A Fetish for Liquidity", you suggest that many DC schemes have both the liquidity and the desire to diversify into more illiquid assets, can you explain why you reached that conclusion?
What we saw from the survey was that in all cases the respondents had positive cash-flows, most well in excess of any short and medium term needs for liquidity. The majority of current assets were readily available and in public listed markets. Respondents demonstrated a desire to diversify their portfolios using these more illiquid assets and to capture the illiquidity premium for their members.
Given the difficult environment we are in currently do you still think that an appropriate way forward for a default fund is a sensible allocation to alternative illiquid assets?
Of course we are in unprecedented times, but as markets recover, and scheme's look at the risk in their current portfolio allocations, and for when we see the next correction, the diversification benefits and the historic performance of these asset types during similar market scenarios can help. With credit spreads widening, the gap between public and private assets has tightened, which is true of markets the like of which we are in now, experiencing such volatility. So although the illiquidity premium is less attractive now, a return to normality and lower volatility, coupled with the diversification benefits still remains attractive.
What did you learn about the way pension schemes might consider private assets in the future, what did they think was an appropriate level, and in your survey how many thought they would allocate?
Master Trusts were far more likely to allocate to illiquid assets (7.4/10), followed by Trusts (4.6) and then GPPs (4.2). MT's and GPP's were broadly in agreement that an allocation of around 25% would be appropriate, whilst the trust based schemes were lower at 15% on average, this seems reasonable as they are generally more mature, and will need liquidity sooner.
And what were the barriers they thought were stopping them from investing in them right now?
Cost was seen as the biggest barrier, followed by generally the issues surrounding platforms and the need for daily prices, valuations and dealing. The other areas of significance were the availability of solutions, the complexity and appetite.
What were the main differences between the GPP's, Master Trusts and single trust based schemes you witnessed overall?
The biggest differences we observed were around the need for immediate liquidity, against the annual cash-flows. Master trusts showed positive annual cash-flows of on average 30% of their current assets, whilst trusts and GPPs were similar in having positive cash-flows in the low teens compared to all having immediate liquidity needs between 3-5%. Further out to 5-10 years, the single trusts had a higher liquidity need, again given their maturity and the age profile of the schemes.
Looking forward, and with NEST leading the way in allocating to these alternative asset classes, what do you believe the rest of the market will do, and how?
Our view is that most other schemes haven't necessarily the scale or internal capability yet to allocate like NEST do directly into these private assets. The market will therefore need to provide them with appropriate "solutions" that are platform friendly and perhaps in the early phases not too complex, and probably at the credit end of the alternatives spectrum from a pricing perspective.
And what about the future?
Schemes are looking forward and are generally positive about allocating to illiquid alternatives, showing their fiduciary responsibility to be prudent about how, and how much, they allocate to the asset classes. It all hinges on when schemes have the scale; the appetite and liquidity is already there.
As consolidation continues in the market, we will see more schemes reaching a scale that needs a more sophisticated default fund offering, and a need to protect their portfolios through diversification and other measures to withstand market events that we have seen historically, and are seeing today. The carbon footprint temperature of the portfolios will also come under greater scrutiny.
Another function of scale, and what we have learned from the Australian market for example, is that with that scale brings many aspects that will support a shift to a higher allocation into these alternative assets. In particular, as internal investment capability grows, the ability to invest directly into these assets and drive fee levels to an appropriate level for any fee cap in place.
For now, and for most schemes for the foreseeable future, we will see the development of solutions that will enable schemes to capture those benefits and as a combination of different asset class specialisms that will be platform compliant, with some daily liquidity, and at a fee level that will suit the UK DC market, given a sensible allocation overall.
Read Natixis' white paper A Fetish for Liquidity in full here
This article was written by Natixis Investment Managers.