Investing in illiquids requires better information


Callum Stuart, Debbie Fielder and Jamie Lawrence discuss illiquids in DC and DB in January this year,

Conversations about illiquid investments have been continuing for some time. My interest in what has become a key element of Government thinking was sparked by this excellent conversation at a Hymans Robertson conference in January

I’m impressed by a comment that appeared on my blog which appeared over the weekend. It refers to my comments on  my blog on Private Equity in Open Ended Funds.

I would recommend reading EDHEC’s full submission to the DWP’s call for evidence on options for DB schemes which closed in early September.
A few quotations will illustrate why:

“Thames Water: far from a unique case of risks that are poorly perceived by investors

These practices must also be put into a market context: for a relatively long period of time, with falling interest rates and high demand i.e., a falling risk premium, the fair market value of unlisted infrastructure asset increased steadily. Keeping assets undervalued for the entire holding period enables managers to show a surprise “bump” in the valuation on exit and to secure their carry, while highlighting their purported ability to select the best assets.

In a different rate environment, these incentives are reversed, and many private assets are now overvalued, as confirmed by recent industry surveys (Preqin Investor Outlook1), but it remains the case that reported private asset values are not representative of market prices and that these practices render any attempt at risk management impossible for investors.”


” For instance, the decisions made by the UK University Superannuation Scheme (USS) to invest in Thames Water, the London water utility, suggest that the plan was unaware of the level of risk and of the true value of the company. Over the past several years, USS invested several times in the famed utility, each time at higher reported valuations. In March 2022, it increased its stake and also reported a higher value for its existing investment, aligning the appraisal of its c.20% stake with that of OMERS, the majority shareholder, a Canadian DB pension plan.

However, in December 2022, OMERS suddenly marked down the value of this investment by 28% (Financial Times, July 2023). In effect, the company is crippled with multiple layers of debt and faces rising costs including debt servicing costs that indexed on inflation. USS now has to recognise the same loss. Many stakeholders seemed surprised by the size of this loss in value.

After all, it seems unlikely that a large water utility could lose almost one third of its value in less than nine months… However, this is not what happened.

The owners of Thames Water recognised a large loss in December 2022 when in fact the company had been getting riskier and losing value for a decade! (a forthcoming publication by mBlanc-Brude & Whitaker develops this case in more details).”

This referenced forthcoming paper doesn’t appear to have been published  yet.

I have taken Dr Keating’s advice and both the advice and the paper proved “good”. EDHEC, is a French business school which takes a keen interest in British social affairs

What Edhec is saying to the DWP

In this response, we argue that DB pension plans in the UK should abstain from investing in infrastructure, unless they are able to do so with enough information about risk and the true market value of these investments.

The response argues that investment in illiquids, particularly in infrastructure is just the kind of thing that pension schemes should be doing, but this is heavily caveated.

The main stumbling block preventing the widespread
development of infrastructure investment amongst DB plans in the UK is the type and quality of data available to investors in such assets has been remarkably poor and unreliable.

The tendency to rely on contributed appraisal data, which is common in private markets, and not on information that accurately represents the risks of the asset class, masks the true characteristics of these investments, and precludes any rational decision-making process when it comes to investing in infrastructure.

It’s argument is not against illiquidity, but against transacting with imperfect information.

Most of the arguments made against illiquidity into UK “pensions” by the pension industry are quite different. At a recent PLSA session in Manchester, John Roe, head of LGIM’s multi-asset team, pointed out that most workplace pensions are hostage to employers (rather than member) redemptions. Roe argued, intuitively, that were a large employer to withdraw from a trust. platform and ultimately fund, the cost of redeeming a large proportion of the underlying assets , might include a significant discount to the book value of the assets. Ironically, the risks of employers forcing redemptions is higher with master trusts than with group personal pensions where the assets can only be redeemed by the saver (there is no bulk transfer of pots in a GPP).

EDHEC’s arguments assume that DB plans will be stable and not look to redeem assets, but this is to think of DB in terms of the few (but large) DB schemes such as USS and Railpen which have stated they have no plans to be bought out by insurers.

Such large schemes are well enough resourced not to make the kind of purchasing mistakes resulting from imperfect information

De facto, we believe the idea of the infrastructure asset class being “too small to be important and deserve attention” is depriving pensioners of the many benefits of this asset class, and it is an excellent thing that this additional knowledge of risks can enable us to emerge from this negative and restrictive status.

So the mistake made by USS of buying into Thames Water as it did, should be considered an outlier. EDHEC says that the data needed to make good decisions is available and argues that with proper oversite, DB  plans should be able to invest in private assets without compromising the fiduciary principles of the Trustees. Infrastructure can provide better pensions at lower cost to sponsors and members.

In this context, it seems important to us
that The Pensions Regulator should set
up best practice rules and require
pension funds to show that they have a
serious investment process for this
asset class, which should not remain
marginal in institutional investors’
allocations due to its macro and
microeconomic benefits

The submission gives ample historic evidence of infrastructure investment delivering what it says on the tin,

The case for infrastructure in DC?

As John Roe reported, most of the large DC schemes are multi-employer arrangements. Some are more prone to redemptions than others. Nest is not exposed to employers moving out, but LifeSight might be. L&G’s own master trust includes Tesco as an employer. There is an issue for unit or share-holders of illiquid funds that a large redemption could hit the pots of savers who weren’t working for the redeeming employers. “Gating” of illiquid funds would be required, or an agreement with each employer in the fund to treat the fund as a whole “fairly”. I don’t see this as a problem in normal times, but the issues associated with DB master trusts with “fair exit” need to avoided. This is where a regulator can help. The Pensions Regulator needs to think about how the master trust assurance framework operates, where a substantial allocation to illiquids sits in the default.

TPR also needs to consider the duration of DC funds. If we are to continue to de-risk DC defaults into liquid bonds in advance of the purchase by the saver of one of the investment pathways, we are building in obsolescence to the member’s pot. A CDC structure – where investment is to and through retirement and where pots are recycled for the benefit of surviving members, is not subject to the tyranny of de-risking. For the purposes of liquidity, a collective scheme is no different as DB or DC – provided it remains open through the entire life-cycle,

Consolidating (DB and DC)

The key issue for EDHEC is consistency of valuations

A key issue when it comes to this consolidation and unlisted private assets like infrastructure then is the prerequisite to obtain precise and consistent valuation estimates of the private assets in the individual DB pension portfolios. As we know already and discussed above, most private asset NAVs in UK plans are not genuinely marked to market and even the same assets can have different marks.

A focus must be given to the quality of methodologies and data and to the independence of the valuations. Ultimately if these valuations depend on methodological choices made by individual funds, then there is a risk of unfair consolidation of the assets.

These issues will occur again and again in discussions and it is well that we have them now and not once the mistakes have been made. EDHEC have done us all a valuable service with their excellent paper and it is good to see such co-operation.

People interested in EDHEC’s views may be interested in their upcoming conference in December

Highlights below.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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