Pension funds and illiquidity

pension-funds-illiquidity-2018Sustainable finance and impact investing are currently high on the government’s agenda.

However, accessing long-term, patient finance can be difficult for projects and start-ups.

In 2017, the Prime Minister asked an independent industry panel of entrepreneurs, academics and investment professionals to consider how to improve the availability of long-term finance for growing, innovative firms. The Patient Capital Review identified defined benefit and defined contribution pension funds as sources of patient capital with the potential to finance innovative firms and also asked how to remove perceived or actual barriers that investors may face in providing long-term finance.

Pension trustees may have different reasons to want to gain exposure to illiquid assets. Some may consider these assets to offer strong investment returns in the medium to long term. Others may focus on how these assets may help to diversify risk in a portfolio by offering returns that are not significantly correlated to those of other asset classes, such as listed equities.

Trustees may also have good reasons to think their scheme’s membership share particular concerns, like wanting to invest in projects and firms that benefit the wider economy, providing employment and stimulating long-term economic growth. Where that is the case, and the investment does not involve a risk of significant financial detriment to the fund, trustees may factor these considerations into their decisions.

The Patient Capital Review found, however, that some pension trustees believe that regulations act as a barrier to investment in illiquid assets. This is consistent with the findings of the Law Commission’s 2017 review of Pension Funds and Social Investment, which concluded for trustees of DC schemes that the absence of clear guidance that illiquid investments are permitted, pension trustees tend to be risk adverse and assume they are not.

As part of our ongoing work to be clearer, as well as quicker and tougher, TPR is going to provide further guidance on how trustees’ investment strategy can include assets with long-term investment horizons, such as venture capital, infrastructure and other illiquid assets in a diverse portfolio.

In the meantime, where trustees consider changing their scheme’s investment strategy to include assets with less liquidity, they need to make sure they have the necessary skills, expertise and appropriate governance arrangements for the complexity of their scheme’s investments, so the risks are properly managed.

By Fred Berry
Lead Investment Consultant