Editor’s Letter – Issue 139

February | March 2019

Hamlin Lovell

While British politicians clearly cannot forge any consensus on Brexit, they do seem to be developing some common ground on alternative investments.

What’s striking is that the All-Party Parliamentary Group (APPG) on Alternative Investment Management – for which AIMA provides secretarial services – operates in a way that’s reminiscent of the consensus-driven, coalition politics that is seen in many continental European countries.

The APPG has just published a paper, UK Pension Schemes and Alternative Investments, exploring the potential benefits of alternative investments for pensions, concentrating on defined contribution (DC) schemes. This focus makes sense since defined benefit schemes, with only around one million active members, are essentially in run-off mode outside the public sector, whereas DC schemes have nearly seven million members – a number that seems set to grow due to auto-enrolment.

Most strikingly, the paper’s projections for future returns from conventional asset classes are not only well below historical levels, but also much lower than the usual actuarial or investment bank assumptions embodied in pension fund forecasts. Given how low yields are it is no surprise to see returns from developed government bonds forecast at only 1.9%. It is perhaps more startling to see returns from equities are projected at only 3.2% – less than half historical averages, and well below the 5-7% range commonly seen. Not only are projected returns from alternatives higher, at between 3.9% and 6.4%, partly due to illiquidity premia, but alternatives can also offer a diversification benefit by virtue of being lowly correlated to other asset classes.

The paper recognises “cultural, regulatory and operational pressures that are encouraging UK DC schemes to shy away from investing in alternative investments”. For instance, public markets are in effect the default choice for pension fund trustees, who must specifically justify any investment that is not publicly traded. The fact that DC schemes typically offer daily liquidity – despite there being no regulatory requirement for them to do so – is an obvious obstacle to investing in illiquids. The absence of an appropriate UK-domiciled professional investor vehicle is another sticking point that makes it more difficult for trustees to access alternatives. The paper recommends ways to alleviate these, but does not in fact recommend lifting the 0.75% annual charge fee cap applying to some UK schemes. It does however suggest that the ceiling could be modified to incorporate an element of performance fees.

The proposals are well co-ordinated with the FCA’s broader initiative to remove barriers to investing in infrastructure, real estate, private equity, private debt, and venture capital – across a range of retail investor funds including pension funds – and the Treasury’s Patient Capital Review, which seeks to funnel more savings into innovative and often smaller firms in the UK economy. The paper is underscored by a formal consultation announced by the UK pensions minister, Guy Opperman MP, to encourage DC pensions to consider investing more widely in illiquid assets including infrastructure, SMEs and social housing projects.

“AIMA and the Alternative Credit Council will respond to the Government consultation and look forward to collaborating with other industry bodies to improve the options for DC pension schemes and their beneficiaries,” said AIMA CEO, Jack Inglis, in his February blog posting on the AIMA website.

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