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Feature | Illiquidity


How the mighty have fallen. In 2014, fund manager Neil Woodford established his own firm after turning every £1,000 of investors’ cash into £23,000 over 26 years at Invesco Perpetual. Pension schemes and retail investors rushed into Woodford Investment Management in the hope that they would benefit from his apparent Midas touch. But in June this year angry investors, regu- lators and politicians queued up to criticize him after he was forced to suspend the Woodford Equity Income fund. It once had more than £10bn worth of assets under management but has now slumped to £3.7bn.


The reason why Woodford hit the panic button: Kent County Council wanted its £260m back and he didn’t have the cash to give it to them. He was having problems returning Kent’s money because a whop- ping 85% of his investors’ capital was tied up in illiquid assets and he was having trouble finding a buyer quickly enough. Those saving into a pension scheme might be worried by these headlines. Could the same happen to them? Would they struggle to get the money they rely on to fund their twilight years when they needed it?


UP THE RISK CURVE Since the financial crisis, the yields offered by high-grade debt have been far from attractive. Indeed, 10-year gilts offered 0.7% at the time of writing. With many defined benefit (DB) schemes maturing and focus- ing on the endgame, equities are playing less and less of a role in their portfolios. Instead, schemes have searched for regular and stable income streams, not growth. This has led many to turn to assets outside of the equities, bonds and cash mix that tra- ditionally filled pension scheme portfolios. Indeed, €1.6trn (£1.4trn) was invested in alternative, and largely illiquid, assets, such as property, infrastructure, private equity, hedge funds and private debt, by the end of June, according to data provider Preqin. This is a €300bn (£2.6bn) rise in three years. In Mercer’s latest asset allocation survey, an average of 26% of pension scheme


portfolios were allocated to assets other than listed equities and publically-tradable bonds. This is up from just 1% in 2003. Contributing to this increase is local gov- ernment pool Brunel Pension Partnership. It has some of its £30bn of assets tied up in property, private equity, private debt, infra- structure and secured income. Local Pensions Partnership, another pool, also has infrastructure interests and the £46bn Border to Coast Pensions Partner- ship raised more than £1bn from its mem- ber funds in July to invest in private equity and infrastructure, its first foray into pri- vate markets.


Institutional investors view illiquidity as a risk that they are paid to hold and fits in with their long-term investment horizon, says Mette Hansen, a director at Redington, a consultancy. “They set illiquidity budgets based on their future cash-flow needs, and within this budget they then determine the most suitable illiquidity premia for them to invest in,” she adds. Hansen warns that those who are actively investing in alternative assets need a


(NEST), the government-backed workplace pension scheme, is working on getting pri- vate credit, European corporate loans, global infrastructure debt, global real estate debt and US mid-market loan funds ready to start investing, it is hoped, by the end of September. Then the search starts for an infrastructure


equity manager, which it


hopes to start building a portfolio for next summer. Far from being concerned over the risks that illiquid assets bring to a scheme, Ste- phen O’Neill, head of private markets at NEST, believes that DC schemes are arriv- ing late to the alternatives party. “Speaking on behalf of the DC industry, we now have the scale and the cash-flows, and the pre- dictability of cash-flows, that make it feasi- ble for us to pick up some of the illiquidity premium that defined benefit schemes have had the privilege of earning for years,” he adds.


The need for stable and regular cash-flows instead of growth has put pension schemes in competition with insurers for assets, which could impact the size of the reward


With £7bn in assets and £450m a month


coming in, if someone tomorrow wants their £300 back, we can square them up. Stephen O’Neill, NEST


strategy and must know what they are buy- ing. “For liquid assets they should ensure their consultants carefully review the actual liquidity and diversification of the underly- ing instruments,” Hansen says.


LAND GRAB Once the preserve of defined benefit (DB) schemes, their defined contribution (DC) cousins are being encouraged to invest in illiquid assets with the government looking at accommodating performance fees for illiquid assets within the 0.75% charge cap for DC funds. Many have taken up the challenge. National Employment Savings Trust


36 | portfolio institutional | June–July 2019 | issue 85


they receive for holding an asset that can- not quickly turned into cash. Hansen says that yields in certain illiquid asset classes have compressed over the past few years, as more capital is chasing a lim- ited pool of assets. “However, whether the “illiquidity premium” is narrowing is a sub- tly different question.” In a bid to find suitable rewards for the risks taken, managers are looking for a “complexity premium”, sourcing deals which some might be unable to do owing to the complexities specific to each asset. They are also looking for value in markets that are underserved.


“Overall, there has been a definite increase


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