The Financial Conduct Authority has opened the door to wider DC investment in illiquid assets by setting out a new regulatory regime for long term asset funds.
In order to facilitate this the FCA has introduced this new category of authorised open-ended funds. Institutional investors and DC funds will be able to invest in illiquids — which can include venture capital, private equity, private debt, real estate and infrastructure — via this new structure.
The FCA’s policy statement outlines the final rules and guidance for long-term asset funds following consultation on this issue.
The FCA says illiquid assets can provide “a useful alternative investment opportunity for investors able to beat the risks of such investments. The ability to invest in illiquid assets through appropriately designed and managed investment vehicles is also important in supporting economic growth and the transition to a low carbon economy.”
The FCA said this new structure, and rules around it are designed to address barriers that stakeholders had said hamper investment in long-term illiquid assets.
This move has been broadly welcomed by the UK pension industry. It is thought many DC schemes may choose to invest in illiquids via these long term asset funds, rather than opting for direct investing in infrastructure projects. The latter option is likely only to be a realistic option for the UK’s largest pension funds.
Aegon’s pensions director Steven Cameron says: “This is at the heart of the ‘investment big bang’ where the Prime Minister and Chancellor are keen to encourage pension schemes to allocate more of their funds to long term illiquid assets including infrastructure projects and ‘productive finance’ in their important drive to build back better and greener. The hope is such investments will also deliver better returns for the benefit of pension scheme members.
“LTAFs are a key stage in the critical path towards DC pensions investing more in illiquids. Trustees and scheme managers may choose this approach to access illiquid investments, investing a small proportion of scheme default funds in these, rather than in individual long term projects. This will allow them to achieve greater diversification and a spreading of risk within this form of investment while also drawing on the expertise of the LTAF manager in this specialist area.”
However Cameron says it is unlikely that there will be an overnight ‘big bang’ rush into this new asset class.
He says: “Members of DC pension schemes now fully expect their pension funds to be priced daily and to be able to switch funds, transfer between schemes or from age 55 access their pensions flexibly, all without any delay or notice period. LTAFs will have notice periods of various lengths and the underlying assets won’t have daily prices with redemptions no more frequently than monthly.
“One consideration will be the length of notice periods set by LTAFs with the FCA prescribing a minimum of 90 days but with some likely to be far longer if targeting certain types of illiquid investment.
“Arrangements for arriving at a daily price between LTAF valuation points to feed into the default fund price will all be critical. Schemes will also need to explore how to manage liquidity within the default fund, when the proportion in the LTAF is not readily realisable. This will in turn require detailed scenario planning including for extreme events and a full understanding of regulatory and capital requirements.”
Hymans Robertson head of DC investment Callum Stewart says: “We are supportive of the FCA’s proposals to extend the range of vehicles for pension schemes to access long-term investments such as illiquids.
“In particular, we agree with the proposal to remove the upper limit on exposure to illiquid investments for LTAFs, which addresses one of the current constraints with existing fund types that has limited innovation.
“Although not required, we also share the FCA’s positive view on work carried out by the Cost Transparency Initiative and that this should be used in the context of LTAFs where at all possible. As always, however, we should consider member needs first. This development should support greater product innovation and choice for DC schemes, and ultimately improve outcomes for members. Member security and the transparency of costs and charges are also important considerations.”
Hargreaves Lansdown senior pensions and retirement analyst Helen Morrissey, says: “Investing in illiquid assets offers a huge opportunity for investors to boost their pension pots by investing in areas such as private equity and infrastructure. However, for this to succeed investors need to be very clear on what they are invested in, what they are paying and what their rights are when it comes to issues such as redemptions and dealing – getting this right is vital to building confidence in LTAFs and making them a mainstream part of the defined contribution landscape in the future.”