The first thing I read in 2023 was the lead story by Josephine Cmubo in the new year’s day edition of the Financial Times.
Her article reignites the fires flaming before the Christmas break over the purpose of pension scheme assets and who can take the risks surrounding the “illiquidity” of private markets.
The OECD’s warning is clear, pension funds need liquidity whether to pay the collateral calls from the leverage in their LDI portfolios, the claims of members on death, transfer or drawdown of tax free cash or pension. If they transfer assets to an insurer or superfund , those assets must be clearly realisable. Nobody wants to be left hanging onto an asset that cannot find a buyer.
The problem corporately funded DB pension schemes have with illiquid assets is that buyers on hand when you don’t need them but are in short supply when you do. The doom loop of LDI was that long-dated and inflation linked gilts were being offered to a market whose principal buyers were the sellers.
Put very simply, many DB pension schemes don’t have time to invest for the long-term and even if they don’t have plans to hand over the keys to anyone who will buy them out, they still have to play the end-game prescribed by the DWP’s funding regulations and the Pension Regulators’ DB funding code. The money in their schemes is already spoken for and there is as much uncertainty about when the money will be needed as there is about the speed at which a cash-call can be met.
The FT report a wholesale move into “alternative” and “illiquid” investments from schemes around the world
Almost half of public pension funds globally with more than $3tn in assets plan to increase their exposure to alternatives, according to a recent survey by the Official Monetary and Financial Institutions Forum (OMFIF). Assets that provide a hedge against inflation, including infrastructure and some real estate, were among those most favoured, the survey found.
It is ironic that overseas investment by pension funds into British infrastructure continues to outstrip such investment by our own schemes. We do not it seems, have the appetite or the expertise to sort the sheep from the goats and work out which of the illiquid investments are offering long term value and which relying on poor due diligence to dispose of assets at valuations that could not be achieved in more critical markets.
Over the Christmas period, I put up details of Edi Truell’s “Long Term Assets” vehicle with the due diligence that is being applied to it. You can click through to it here and work out whether you’d want your pension secured by it.
It is a sad truth, that Truell’s Pension Superfund, with its intention of managing pension liabilities over time using the Long Term Assets investment approach, enters 2023, still to get approval from The Pensions Regulator.
The Pensions Regulator is looking to protect itself , the PPF and the large DB schemes that dominate its thinking by encouraging the short-termism that other parts of Government condemn. It has been stung by criticism that it did not properly oversee LDI, but LDI was a construct, flawed not by the illiquidity of growth assets , but by the illiquidity of the Government debt market.
The OECDF’s warning shows how leveraged LDI, created a false sense of security within the pension system. Corporate pension schemes could not have their cake and eat it. So long as liability valuations are pegged to institutional borrowing rates, the death loop applies
“Chasing higher returns in relatively illiquid markets gives funds less flexibility to change their strategies in future,” the report said, adding that “the recent UK pension crisis suggests it is necessary to hold liquid assets as a way to instantly raise cash in bad times”
The reason why pension schemes had to gear up their holdings in specialist gilt markets was to satisfy the vagaries of liability accounting. The recently announced draft DB funding code makes it clear that the Government has no immediate intention of changing the rules. Until it does, DB pension schemes will be unable to take the long-term view needed for illiquid investments.
Savers can take risks that their employers can’t
Having effectively castrated its major source of funding for “productive capital”, the Government is now asking savers to take this risk on.
The pressure is on trustees of large workplace pensions where savers (not employers) take these risks. The Government’s own DC Pension Fund – Nest – has been increasing its exposure to illiquids in this way.
Ironically, Nest and other DC schemes are less likely to have to liquidate than corporate DB schemes, mainly because the master trust assurance framework set in place by the DWP and TPR encourages workplace pensions to take the longer view. No one is telling Nest or People’s that they must be self-sufficient, that they should prepare for buy-out , that they need to match assets to liabilities. TPR’s mixed messages jar with its current mantra ” Making workplace pensions work”.
These mixed messages become even more confusing as the FT also reported this morning that the Government is about to launch a fund to help capital deprived communities build back – “The Community Wealth Fund” will be created from the proceeds of forgotten bank accounts and operate independently of the Treasury.
“The key differences are that this fund would be administered by a separate institution, not Whitehall, and importantly this money is not part of government expenditure, so it is not time limited.”
For the Community Wealth Fund, read Nest and other workplace pensions.
The value of time
Over the Christmas period, the FT had put out advice to young investors who had been bitten by the sharp markdown of tech stocks and especially crypto-currency in 2022
Now for a reality check. While 2022 was a challenging year for investors, there is every possibility 2023 could be even worse. That ought not to spark panic. The financial odds are stacked against the young in many ways, but as investors, the greatest advantage they have is time.
If markets fall, they will be buying stocks at lower prices, and their long-term returns are going to be higher decades into the future. That is worth remembering when the temptation strikes to sell up or abandon investing altogether, which would mean missing out on the rebound — whenever it happens.
The new year could be the time to learn about a new way of investing. Have faith that the long-term rewards will be worth it.
How ironic that we are asking our younger savers to take risk , while we refuse to take risk in our mature DB schemes. How ironic that the Pensions Regulator, that should operate to a common purpose , treats risk so differently for DB and DC “savers”. How ironic that a Government demanding we invest in Britain to build back better, is stymied in doing so by risk aversion of the “pensions industry”.