I’ve been reading the Productive Finance Working Group’s (PFWG) paper designed to remove the barriers to our workplace DC schemes investing in productive but illiquid investments.
They have a tough task ahead of them convincing the purchasers of workplace pensions to pay more for less liquidity in return for a promise of better long-term outcomes. This article argues that the purchasing agents of workplace pensions are employers. They are not part of the PFWG.
So who are the people in this group and what’s in it for them?
It’s a collection of trade bodies, insurers , asset managers, consultants , a few trustees and one pension scheme (BT). The significant stakeholder missing , is the employer – the source of funds for DC pensions and the purchasing agent for 25m UK savers.
The Steering Committee of the Working Group is co-chaired by the Bank of England,
the Financial Conduct Authority (FCA), and HM Treasury (who also provide secretarial support). They know very well , the importance of employers.
If square pegs are to be driven into round holes, the PFWG is the way the Government believes it can get things done. So far, it has failed to win the argument for illiquids in DC.
In November 2021 , a new investment vehicle – the Long Term Asset Fund (LTAF) was launched to help with the three big barriers to getting productive illiquid investments into DC schemes. The LTAF, it was hoped, would help with liquidity, would shift the focus of purchasers from price to value and to give those who manage and package illiquid investments , an ongoing right to performance fees.
As far as I am aware, no LTAFs have been launched. Why ?
PFWG describe take up as “relatively slow” (relative to what?) and blame this on
“the hesitancy that has been displayed by the industry in pushing ahead with investing in less liquid assets”.
A particular sticking point has been striking the balance between, on the one hand, continuing to provide cost efficiency to members of DC pension schemes and, on the other hand, delivering long-term value via investment in less liquid assets to improve the potential return earned on member savings.
The solution , the PFWG feel ,
is to empower employee benefit consultants to shift the focus from cost to value when advising DC decision-makers. Consultants have also issued a call to action for DC investment platforms to evolve their processes and systems to support investment in less liquid assets, which should aide implementation in practice.
It’s an “if we build it – they will come” approach but consultants will be wary. They are typically paid by employers not by trustees or members. They see risks through the eyes of their paymasters and though there is a general sense that investing in private markets will improve member outcomes, there is also concern that along the way, there may be casualties. So the question is …
Will the consultants make a difference?
Part of the problem with imposing a top down solutions such as the LTAF is that the buyer is not immediately available to have a conversation with. The buyer is the employer and the employers are not represented on the PFWG. The PFWG represents a group of complex interests where “for profit” and “not for profit” sit gingerly on the same bench.
Commercial master trusts are owned by insurers , by consultants and some by private equity (Cushon and Smart for instance).
Not for profit master trusts are sometimes advised by consultants but generally have their own research departments. The largest – Nest – is owned by the Government and is the obvious standard bearer for the LTAF in a DC scheme ,but – as far as I can see – Nest has not used an LTAF.
It is hardly surprising that consultants are not proposing LTAFs in the circumstances (even where the consultants are providing the workplace pensions – WTW, Mercer and Aon are on the PFWG’s steering group both as consultants and funders of master trusts.
Where the fine lines between “for” and “not for” profit, between consultancy and fiduciary management and between value for members/shareholders and funders is constantly being withdrawn, consultants are part of the “hesitancy”.
The PFWG’s diagram of the decision makers for purchasing LTAFs and increasing the exposure of DC schemes to productive illiquid investments looks like this
And herein lies the problem. The long term funding of DC remains the business of employers and employers are not represented on the PFWG steering group. Employers are ultimately answerable not to Government or consultants or even to trustees – they are answerable to the members of the workplace pension scheme they (as the employer) have chosen.
Right now, employers are concerned about their workplace pensions because they can provide them with reputational risk (employees can turn on bosses as has happened in the USA) where insufficient due diligence has been done on the selection of a provider or of trustees competent to take decisions.
These risks can manifest themselves through
- High charges which drag back performance and cannot be justified relative to lower charges on the market (most tenders finally get decided on price)
- Operational failure historically this focussed on AE compliance but is now shifting to member related risks related to non-availability of retirement options
- Investment failure we have yet to have a workplace pension fund blow-up, though some will argue that this is happening to those stranded in defaults overly invested in gilts and bonds.
- Liquidity failure so far, “gating” of funds has been limited to property funds and has not caused any default to be forced to suspend claims. But were a major default not to be able to meet claims because it was overly invested in illiquids, the consequences would be serious, they could well require an injection of liquidity from “elsewhere” which is not the kind of thing employers like to think about. A list of the likely scenarios where a liquidity crunch could occur on a DC default is included on page 38 or the guidance – it does not include a run on the default by members.
DC providers have ridden failures with high charges, compliance breaches, sudden falls in investment values but they have yet to be tested by the gating of a default fund. I suggest that a run on a default fund could and would happen if it were overly invested in productive illiquid investments that could not be realised. Although LTAFs can use risk management tools to prevent gating, they can be gated.
I don’t think that many employers are going to be comfortable selecting or maintaining a workplace pension provider who is perceived as running a default fund that could be gated.
This is why, I think the future of illiquid investments lies not with LTAFs but with publicly listed investment trusts which have their own problems (discounting of assets to true value) but which do not get gated.
Run properly , with full disclosure and with proper due diligence conducted on all the agreements within the investment structure, I believe that trustee can see such publicly listed vehicles as a means of accessing value without putting the default at the extreme risk of temporary closure.
Employers are key
Employers are key to the investment of DC defaults. They need to take decisions on their workplace pensions based on value for money and many will see a progressive approach to using private markets within a default as positive, provided that it does not substantially move the dial on charges, compliance, investment risk and does not put at risk the rights of staff to have their money when they are due it.
Having read the PFWG’s working group’s guidance, I am broadly in agreement with its approach to VFM, its aims to improve value for members relative to equivalent holdings in index-trackers and I can see that care is being taken to limit many of the issues with private markets surrounding “dry-powder”, “hidden fees”, “valuations” and “transparency”.
But employers are a long way from buying into a world where their members pay more for less liquidity and a vague promise of better outcomes. There has to be a more compelling reason for employers ( on behalf of their staff) to support a workplace pension and that case must be made around the fundamental value of private markets as a source of growth in member’s pots and pensions.
An employer value proposition is needed , for private market investment to develop in DC.
The fundamental problem employers have with pensions remains. Employers are represented by employees and so far we have not moved far from this statement by the Office of Fair trading in 2013.
Employers need to be bought into workplace pensions before workplace pensions move into private markets. They need to see the value proposition and it needs to be pitched as part of a national campaign of awareness , supported by the CBI , the FSB and promoted by Government as well as it promoted the introduction of Auto-Enrolment.
I see little effort to do this at present, perhaps that is where the PFWG should focus their efforts.
There is only one thing to realise with illiquid investments and that is that you will not be able to realise their value when you, as a DC saver, need that cash. There is no illiquidity premium; it is liquidity which has a cost. With illiquids that cost is realised on sale, that is their conversion to liquidity.
More than a few DB schemes discovered just how far from the valuations offered by managers their illiquid investments during the LDI crisis. Liquidity was then at a very high premium.
About the only form of illiquid that might be acceptable would be an illiquid instrument which is self-liquidating on some contractually defined timetable. We used to know those as amortising bonds.