What are they?
Illiquid assets are assets that cannot be easily sold for cash in normal market conditions. Examples of illiquid assets include:
- Property
- Infrastructure
- Private equity
- Private debt
- Some parts of the corporate bond market
Illiquid assets may be hard to sell because of a lack of ready purchasers and/or an actively traded market and/or they may be difficult to value.
Illiquid assets tend to have greater trading costs and volatility, and as a result can pose greater risk to investors than readily tradable investments, with regard to liquidity.
Why invest?
There are two key reasons why pension schemes should consider illiquid investments, given the often long-term nature of pension scheme investing:
- The “illiquidity premium” is the additional expected investment return for those investors able to lock away assets for the medium to long term, without the need for the ready liquidity on that portion of assets; and
- Illiquid assets can often generate regular income and cashflow profiles that can be used to match the cashflow needs of a pension scheme.
For a pension scheme that has a long-term investment horizon, for example a scheme that has an objective of running down the liabilities of the scheme over the long term, illiquid investing can be an attractive proposition.
When not to invest?
An example of when not to invest in illiquid assets would be when a scheme has a shorter time horizon. For example, if the scheme is targeting buyout with an insurer for all, or a portion of, its assets in the near to medium term, then clearly this is not compatible with the need to liquidate the portfolio to transfer assets to an insurer.
Another example of where this issue would need to be considered carefully is where a scheme has a weak covenant and there is risk of the insolvency of the employer that could result in a forced buyout or transfer to the Pension Protection Fund. If, in these circumstances, a scheme needs to liquidate assets, then clearly this is not compatible with illiquid investing.
Accessing Illiquid Investment and the current outlook.
For larger schemes, direct investment or investment in closed ended funds for assets such as private debt and infrastructure may be attractive. For smaller schemes, it may be most efficient to access illiquid assets through multi-asset funds, although some dedicated allocations to illiquid credit or private debt may still be feasible.
It is important to assess scheme specific circumstances, but many illiquid opportunities can offer attractive long-term return expectations, especially set against current valuation metrics for many “core” assets, such as equities and bonds.