The search for yield

by Simon Cohen   •  
Blog

As equity markets are at all time highs, bond markets are performing strongly and most other asset classes look fair to overvalued, many pension scheme investors are asking where they can get the extra return that they need to help fund their deficits.

One area that investors could consider is investment in illiquid asset classes.

What are illiquid asset classes and why might they be suitable for pension schemes?

These include asset classes like infrastructure, private equity, private debt and even property. The key attribute of these investments is that investors have to commit to and lock their assets away for a period of time. In return for this commitment, the investor should receive an additional return – the illiquidity premium.

The illiquidity premium can be thought about in the context of investing in a bank account. You could put your money in an instant access savings account, but you would receive a very low (if not zero!) interest rate.

Alternatively, you could invest in an 18-month deposit account where you would get a better interest rate, for example 0.75% a year, but you are not allowed access to your money until maturity unless you pay a penalty of the interest earned. I know the difference in interest rate isn’t great, but at least it is extra return!

The principle is the same for these asset classes. Investors commit to investing and then typically capital gets called over time and then the money is locked away for a period of time until the investment matures. This type of investment is great news for pension schemes. Most pension schemes have a long-term time horizon before they need to disinvest all their money (albeit schemes are maturing quite quickly), so they can afford to lock some of it away and receive that extra return. Some of these investments, once fully invested, also distribute regular cashflows and potentially even inflation-linked cashflows, which again suits a pension scheme that has to pay its pensioners who receive inflation-linked pensions.

These types of assets are proving more and more popular, albeit commercial property in the retail sector is suffering from the impact of COVID-19 and the general move towards online shopping. Even the government is keen to encourage investment in such classes, including infrastructure projects.

If illiquid assets are so suitable for pension schemes, why aren’t all pension schemes investing in them?

Well, more and more are, but they are not suitable for all schemes and they do have their drawbacks (apart from being illiquid). For example, there is a lot of money “chasing” infrastructure at the moment, which is pushing up prices. Typically, managers might charge quite high fees for managing the assets which eats into returns. Also, many of these investments have a high minimum investment size, which smaller schemes may struggle to meet as part of a diversified portfolio.

If you would like to find out more about these types of assets and whether they are suitable for your scheme, you should contact your investment consultant.

Further reading

Pensions Accounting Update As at 31 March 2024

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by Angela Burns   •  

Pension scheme dynamics: Are we repeating the mistakes of the past?

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Is your DB scheme an asset rather than a liability?

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