Dinosaurs or scapegoats? Why platforms get blamed for lack of illiquid assets in DC
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Platforms are sometimes portrayed as the roadblock on the highway to illiquid investments for defined contribution pensions. Is this a fair assessment?
Asset managers and consultants sometimes accuse institutional platforms of sticking to outdated methods, such as daily dealing and IT systems that might not be geared up for assets which are not priced and dealt on a daily basis – thus hindering the greater adoption of ‘illiquid’ asset classes like infrastructure and private equity.
The government has shown interest in changing this; it wants more investment in illiquid assets, or ‘patient capital’, from pension funds in the hope that this will support the UK economy and infrastructure needs. It is keen on removing perceived regulatory obstacles like the permitted links rules, which limit the proportion of illiquid assets in unit-linked funds.
Currently there is a combination of limits on asset classes considered illiquid. The FCA consulted with the industry on lifting the current caps to a new overall limit of 50% earlier this year, with final rules due this quarter.
Should pension funds exert pressure on platform providers?
But in the eyes of the industry, the permitted links rules are far from the only thing slowing down DC and illiquid investment.
Phil Dawes, head of sales UK & Ireland at BNP Paribas Asset Management – which created a monthly dealt private credit fund for master trust Nest – says some providers are reluctant to open their platforms to illiquid funds with monthly pricing and monthly dealing.
“There are providers with sizeable market shares whose systems are just not aligned to investing in illiquids. This will only change if asset managers, asset owners and investment consultants pressure the platform providers to introduce the flexibility required,” he says.
Monthly pricing should not create any issues in DC, he argues, because the vast majority of members invest in the default fund and contribute through payroll, which is normally monthly: “Contributions are monthly hence monthly dealing and pricing should be sufficient for member purposes. Daily liquidity is generally not required by members but is simply a stipulation from the platform providers.”
A default fund holding 15% of assets in illiquids would remain sufficiently liquid in his view, and the age profile of DC members would mean that inflows will outstrip outflows for some time to come, so even where liquidity cannot be made available from the bulk of liquid assets within a default, monthly contributions could be used for any redemptions, according to Dawes.
Chicken and egg situation
Not every platform is the same, of course. Laura Myers, head of DC at consulting firm LCP, says there are big differences between platforms – typically, investment-only platforms are more flexible than bundled ones or master trusts, she says.
“Recently we’ve been able to add a daily dealing illiquid fund created for the DC market onto several investment-only platforms for clients to access,” she says, while “for another client on a bundled platform the same fund was refused due to the gating requirements of the fund”.
Platforms have become more flexible over the past few years, she adds, as larger investment-only platforms are now more willing to accommodate client needs and adding new funds.
There can however be a chicken and egg situation, notes Myers. “Platforms won’t launch a fund on the platform and undertake the work that comes with that without a client guarantee that they’ll put assets in the fund,” she says; at the same time, some clients might choose from funds on the platform as it will be quicker to move to those than wait for a fund to be launched.
Are illiquid funds economic for platforms?
It is not unreasonable for platforms to wait for the support of a large pension fund or consultant before offering a new fund, argues Rona Train, partner at consultancy Hymans Robertson. The platform needs to be confident that enough money will flow into the fund “to make it worth their while adding it”, says Train, as the provider will need to govern the fund on an ongoing basis; this involves costs, as does the initial setting up of the fund.
Jason Bullmore, workplace investment lead at Aviva, which offers a platform for DC clients, believes there is a strong investment case for workplace pension schemes accessing illiquid assets, but adds that challenges need to be overcome first.
Bullmore cites cost and “operational considerations, including, for example, the structure of the investment vehicle that holds the illiquid assets, dealing frequency, liquidity and how performance fees, if levied, are fairly applied”. Physical property is, however, already being offered by platforms including Aviva’s, he points out.
With performance fees the charge cap on default funds of 0.75% also needs to be considered, he notes, because “strong performance could result in the charge cap being breached as a result of the performance fee kicking in”.
For Bullmore, the permitted links rules seem to be less of a problem; he says structures are available that are compliant with the requirements of these rules, even before the FCA potentially changing them.
IT systems can make the difference
One newer player in the market, which focuses only on providing an institutional platform, is Mobius Life. The majority of its clients are DB schemes, but some are DC, and the provider sees a need for illiquid funds among both types of schemes, saying smaller DB schemes also lack access to the illiquidity premium at the moment.
The provider is about to launch funds to the market that are not daily dealt, with two as yet unnamed asset managers. Institutional distribution director Craig Brown believes there is demand from pension funds for these products - and that illiquid funds will benefit pension funds.
One of the things that has allowed Mobius to move faster on illiquid funds than others is the fact that its IT is outsourced. "We don’t have any legacy system if you like,” he says. “One of the benefits of not having internal team is you develop a system according to client needs."
A system redevelopment is normally required to cope with funds that are not daily dealt where a platform has its internal system – and there are still many legacy systems out there, claims Brown.
As a result, “not everyone is there yet”, he says. "As with a lot of things in [pensions] these things take a little bit longer than everyone would like.”
Are platforms an obstacle for DC (and small DB) schemes wishing to access illiquid assets?