Real assets: mallowstreet Insights seeks to answer questions about investor interest

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A webinar I watched in April 2019 suggested that infrastructure investments may double over the next 16 years. But few new infrastructure and real estate funds launched in 2019, and the market continued talking about the issue of ‘dry powder’ – too much cash chasing too few opportunities. 

Are UK pension schemes looking to increase their allocations to real assets? How does their choice of end games influence their ability to invest in illiquid assets? Do they see illiquidity as an advantage or an obstacle? And are DC schemes developing an appetite for real assets? Looking to answer these questions in an upcoming Real Assets Survey, mallowstreet Insights reviews recent developments.  

Is demand for real assets on the rise?

Research by Aviva Investors found that 53% of European pension schemes are looking to increase real estate allocations in the near future, with just as many eyeing further infrastructure investments. 

However, consulting firm Aon found that while many UK DB schemes are switching out of listed equities, only a quarter are increasing allocations to less liquid assets. Many questioned the risk-adjusted attractiveness of such assets when looking to meet return targets. 

Border to Coast Pensions Partnership made several investments into private markets, including infrastructure, and the London CIV launched its own infrastructure fund, while preparing the launch of a real estate vehicle. Master trust NEST is about to launch a manager search for illiquid assets, including infrastructure equity. 

Are real assets an obstacle to buyout?

Schemes approaching buyout in the next five years hold an average of 27% in growth assets, nearly double what they would have expected as good practice, a study by Barnett Waddingham showed. The average exposure of these schemes to illiquid assets was 4%, and the consultancy warned that five years may not be enough time to unwind such assets.

This concern is not unwarranted – the Solvency II capital requirement remains at 25% of the value of real estate investments, even though the European insurance industry has long lobbied for its reduction. This means that real estate assets cannot be transferred easily to an insurer in the event of a buyout. 

The European Insurance and Occupational Pensions Authority (EIOPA) hinted that the capital charge might be inadequate, and ran a consultation which closed on January 15. While the capital requirement is not expected to change soon, some see these developments as encouraging. There is new data suggesting a lower capital charge might be more appropriate. 

Is illiquidity a concern for real asset investors? 

Last year saw the collapse of the prominent Woodford Investment Management and the gating of an M&G physical property fund. Both events were caused by liquidity issues within the funds. 

New rules for open-ended property funds are trying to reconcile the illiquid nature of real assets, such as property, and the need for liquidity of retail investors. These rules may be relevant for DC schemes who need a daily liquidity structure, and smaller DB schemes who may invest via pooled funds. 

The FCA already introduced new rules for non-UCITS retail schemes, requiring clear and prominent information on liquidity risks and the conditions under which investment redemptions may be restricted. 

What about DC schemes?

USS has recently announced that it will open access for its DC master trust members to its private markets portfolio, which includes infrastructure and property amongst other asset classes. This is not the first time a DC scheme has accessed illiquid assets.

NEST made a decision in 2019 to invest up to 5% of its default funds in private debt. In January 2020, NEST invited managers to tender for unlisted or direct infrastructure equity funds, asking in particular how “NEST can access the asset class” and stating its interest in “stable, long-term returns even in difficult market conditions”.

The Department for Work and Pensions ran a consultation on illiquid investments in DC schemes in 2019, and is considering launching new regulations in October 2020. This follows a 2017 commitment from the government to make investments in infrastructure, private equity or social housing easier for DC pension funds. 

Additionally, the British Business Bank launched British Patient Capital in 2018 – an initiative to enable long-term investments in high-growth companies. As part of the initiative, it commissioned research from Oliver Wyman to study the feasibility of such investments in DC portfolios. The report suggests investment trusts and unlisted vehicles as appropriate for DC schemes looking to invest in private equity. 

We believe these developments can open up further the conversation about DC schemes investing in illiquid assets such as real estate and infrastructure, and will be studying these and other developments in our upcoming research projects. 

As a pension fund, is your scheme looking to increase investments in real assets, and why? 

As an asset manager, are you seeing greater demand for real assets from UK pension schemes?