COVER STORY
these areas. “We should all be pushing investment managers and DC platforms to innovate and come up with new solutions, at reasonable costs, in this area,” LCP urges.
How to build illiquids into your portfolio Pensions Expert asked consultants and asset managers what a more appropriate asset allocation for a DC default would look like. Experts agree that, generally, illiquids need to be a large enough commitment to be meaningful, while maintaining diversification. “You need to have a nice diversified allocation, and it needs to be somewhere between maybe 10 and 20 per cent,” says Maria Nazarova- Doyle, principal at Mercer. Exceeding this range could mean schemes are
caught out by cash calls, while at below 10 per cent the allocation’s benefit to member outcomes may not be worth the work and cost for trustees. This allocation will usually need to be reduced as members near retirement begin to consider their options under freedom and choice, to allow for greater liquidity. Ms Nazarova-Doyle says that ideally schemes
would opt for a mixture of assets – such as direct property, infrastructure and private debt. She is keen on the idea of private equity, but admits that it is probably the most difficult alternative asset class to incorporate into DC. Private debt and property, on the other hand, are probably the easiest.
Mr Byrne agrees that schemes need to diversify
across a number of asset classes tomanage specific risks. “You need a big enough allocation to make a difference, but not so much as to challenge the liquidity of the overall default strategy,” he says. Furthermore, schemes will also need to fit within
overall cost constraints. “This tends to mean an allocation of the order of 10-20 per cent split across assets,” he says. One of the main advantages of including more
alternative assets is better diversification across the DC default, says Jon Parker, director of DC and financial well-being consulting at Redington. There are also potentially higher returns for some types of illiquids compared with developed equities, he says. He adds that, depending on the type of illiquid
asset, “there may be some risk reduction”. Valuations on commercial property, for example, might take place every quarter rather than every day, usually resulting in smoother cash flows. Support for illiquid assets in DC has been
growing. In February, the Department for Work and Pensions published a paper on illiquid assets and the development of scale in DC schemes. In his foreword, minister for pensions and
financial inclusion Guy Opperman urged schemes to think about a broader range of assets, “which help diversify and improve returns to beneficiaries”, noting that these same assets also drive new investment in important sectors of the UK economy.
21
IN DECEMBER 2018, 36 PER CENT OF SCHEMES HAD
ALLOCATED MORE THAN 75 PER CENT OF THEIR DEFAULT STRATEGY
TO EQUITIES
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