Finding the right neck of the woods (for DC illiquids).

The appropriately named Guy Rainbird has commissioned work from the PPI that confirms a belief among many who understand investment trusts, that DC funds would be well advised to access the returns of illiquid assets through investment trusts.

I’m quoting from a press release to be found on the Association of Investment Companies website (the depth of my investigative journalism!)

“How default funds should access these assets is a key question. Investment companies are tried and tested vehicles for investing in illiquid assets. They have a closed-ended structure that protects funds against fire sales and suspensions while offering liquidity through their listing on the stock market. They have a track record that in some cases extends back beyond the global financial crisis. This does not apply to other proposed solutions for allowing pension funds to access alternatives, such as the Long-Term Asset Fund (LTAF), which would rely on notice periods to resolve liquidity mismatches and could run into problems if those notice periods prove too short.

“The fact that investment company shares are traded on public markets provides the ability to adjust a scheme’s exposure, perhaps because of a change in strategy or in response to operational needs. These qualities could make investment companies particularly worth considering for smaller funds or those wanting to test the water and build their interests over time.”

Those who argue against the use of closed end companies will of course point out that most trade at a discount to the valuations of stocks they hold. This, to my simple mind, suggests that the valuations may be artificially high rather than the shares of the investment companies , artificially low. To value assets that you cannot readily sell at the price you think they are worth when a market for them emerges is speculative. To manage the liquidity risk through the share price of the company holding the assets , seems more transparent. Let the market decide.

So what of the report?

Accessing ” Could DC pension default investment strategies better meet the needs of members?”, is surprisingly difficult. I got there with the help of twitter


The title is ambiguous, DC defaults do already manage the savings of 91%  of those in DC pension schemes, from a marketing perspective, they have been the grey squirrels, establishing supremacy, much to the despair of “red squirrel asset managers” not  chosen by DC platforms as default suppliers. Hence the whoops of glee, from trade bodies at Government support for alternative assets, alternative fund structures and alternative managers. The red squirrel has protected status.

From the AIC’s press release , I had supposed that the import of the report was that alternatives are likely to improve returns in defaults without increasing volatility, something that the PPI has said before.

But this is not the import. Instead the PPI are arguing that there is a cased for “tailored defaults” established through a better understanding of member data, which could be applied to different groups of savers within a schemes. Each of these tailored defaults could have its own investment strategy , meaning that alternatives could be included or excluded from people’s savings, depending on the scheme design. Essentially, this means trustees and/or platform managers deciding on what your investment strategy should be.

I am not sure how far down this rabbit-hole fiduciaries and providers would be prepared to go. It is one thing to give some people a strong nudge (for instance to special interest funds such as Sharia invested), it is another to herd groups of savers, according to your understanding of their data. As soon as you get members taking active decisions, you have moved away from a default into what used to be called “core funds”.  Those involved in scheme design around the millennium will remember how core funds became extinct as a single default took over.

Nor am I sure that “tailoring defaults” can be achieved through behavioral economics. The PPI sound on unusually shaky ground when they start generalising about what contribution flows and asset balances tell us

For example, those with a high account balance might be regarded as having more to gain from
more customised investment approach, be able to afford higher member charges, and bear more
risk, so that group might receive targeted communications about their options. Though some of
those with high account balances may still be highly dependent on their DC income or have a low
risk-appetite, so any communications will need to be carefully designed. Schemes or employers
informing members about appropriate investment strategy could also be seen as giving advice,
which is a regulated service. Therefore, some form of protection for the provider of the prompt
would need to be built into the system.

The majority of the PPI’s report gamely follows the premise that tailored defaults are what its readers are interested in, though I suspect most will be focussed, not on a more sophisticated scheme design, but a more sophisticated default – one that gives red squirrels a chance – or more properly “improves member outcomes”.

So I will skip over the long and tedious chapter on defaults that offers us insights such as “Low-risk strategies generally yield lower returns” and  “Investment strategy design involves trying to find the right balance between risk and return”.

I will skip too the arguments for investing in alternatives , which are made most persuasively by BlackRock’s table, included again in this report

Instead I’ll focus on a table in the later stages of the report , which should be considered by any red squirrel manager, looking to target their marketing

If red squirrel managers can identify the characteristics of their funds as offering high but erratic returns, or low but consistent returns, then we have a  practical application for this research. But my experience is that we have yet to find ways to understand the membership of the schemes we are in – other than when they have chosen a strategy for themselves. People do not identify themselves with placards saying “I’ve got DB benefits, come and get me”, who knows if someone has supplementary savings?

The best we can do is identify savers who have stopped saving (into that particular scheme) by the fact that no more contributions are coming in for them, or that someone is taking UFPLS – because the tax treatment of the fund says they are. This the PPI try to do using Frances, Sam and Alex as sample members. While the modelling is great, I am unconvinced by the conclusion

Gather more data on members in order to make DC default investment strategies more tailored, or to provide prompts about non-default (self-select) investment strategies

Consultancies have been trying this for decades now- with little discernable success. There is considerably greater homogeneity in the way we save and “self-selectors” are often the people you least expect, one of the most engaged groups of savers I ever met worked on the night shift in Heinz’ Wigan food processing factory.

So finally…..

Having read through 60 pages of this report, the last 24 of which relate to modelling the scenarios in the returns/volatility box, I return to where we started.

Alternatives have a place in DC defaults and the PPI report shows why. But alternatives have the capacity to screw everything up , if they go wrong – and they generally go wrong when the assets can’t find a buyer.

All of the base case scenarios modelled by the PPI could benefit from the greater returns , lower volatility and the diversification offered by alternative assets (though the assets need to be tailored to the scenarios).

But if the alternative investments screw up, everybody loses. Something that is not mentioned in this report.

What we really need to understand is whether the investment trusts into which alternative assets have been purchased, have advantages over open ended vehicles such as LTAFs.  This is not something that the report touches upon.

So let’s hope that someone will do that piece of work, for now – we must be content in knowing that red squirrels thrive where liquidity rains, and asset managers who can find protection through closed end companies such as investment trusts, are in the right neck of the woods.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to Finding the right neck of the woods (for DC illiquids).

  1. con keating says:

    Appendix D of our submission in response to the charge cap consultation showed the performance of a selection of investment trusts which are invested in private equity and venture capital – the full submission is here:

  2. Pingback: Disclosures “contrary to the public interest” | AgeWage: Making your money work as hard as you do

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