The UK pensions market is experiencing seismic shifts in asset allocation. Defined benefit schemes are exiting illiquid investments, leaving asset managers eyeing defined contribution counterparts as a possible replacement. JTC’s Director of Fund Services, Will Turner, examines how such a transfer might play out.
More than £1 trillion of UK defined benefit (DB) pension liabilities are predicted to move to insurers in the coming decade[1], as corporate sponsors seek to offload the burden of providing millions of retirement incomes from their balance sheets.
2023 was a landmark year for the UK bulk annuity market, as schemes took advantage of their newly fully funded status – driven by higher interest rates – in the form of an estimated £50 billion of retirement income secured through buy-ins and buyouts. That included five transactions of over £2.5 billion[2].
This seismic shift in assets from one set of institutional investors to another means fundamental changes to investment strategies. Trustees will need to switch from allocations to illiquid and return-seeking assets, to those that match insurers’ risk profiles.
No longer will private asset classes including real estate be deemed suitable for billions of pounds of retirement savings and, as a result, UK core property funds are experiencing significant redemptions.
These withdrawals come at an unfortunate time for real estate managers – when asset values were already falling. Debt-backed real estate buyers were seeing borrowing costs increase, while higher risk-free rates were translating into higher required returns for equity buyers. So, as we saw at the end of 2022, there is a wide disparity between the pricing aspirations of both buyers and sellers[3].
No wonder, then, that asset managers have been forced to defer redemptions and put restrictions in place.
Ultimately, however, such efforts only serve to stem the outflows and managers will need to find new investors.
In search of alternatives
Enter the burgeoning defined contribution (DC) sector, where this year contributions reached £9.9 billion, overtaking those of their DB counterparts for the first time[4].
While the DC universe is still a relative minnow compared to the DB world, these assets represent a significant opportunity for property managers to recoup their lost investments.
Yet challenges remain in realising the DC potential.
First, DC schemes have been reluctant to invest in illiquid assets, seeing them as potentially higher cost and slower to generate value than more liquid options.
However, the UK government is keen to capture DC’s capital, using it to drive investment in all private markets and, in a 2023 review into expanding investment opportunities for the sector, it noted: “DC pension schemes can afford to take a longer-term view with investments so they are ideal vehicles for investing in illiquid assets which could deliver members higher net returns as part of a diversified portfolio that balances risk and opportunity.”[5]
Finding suitable products in which DC schemes can realistically invest in real assets remain a work in progress.
Buying property directly outside a pooled structure is unlikely to be an option for most DC pension providers, given the size of investment required for a diversified portfolio, the ongoing governance and management requirements, the property-specific risks, and the issue of pricing illiquid assets. However, as DC pension schemes grow and market norms change, this may become a solution in the future for larger DC providers.
Pooled open-ended funds investing across a wide range of properties offer investors relatively easy access and some asset managers have created funds that offer relatively frequent liquidity windows.
Meanwhile listed property vehicles such as real estate investment trusts (REITs) also offer a route to the property market. However, they are often leveraged compared to pooled funds and are also still invested in illiquid assets, meaning the listed prices of the vehicles can suffer from higher volatility and dislocations from the valuations of the underlying properties, particularly if a large number of investors want to exit or enter the same vehicle.
Making life simpler
A more recent and potentially game changing addition to the market is the long-term asset fund (LTAF), which makes it easier for DC investors to access asset classes such as real estate.
Last March the Financial Conduct Authority authorised the first LTAF – an open-ended authorised fund designed to “invest efficiently in long-term assets”.
In the past year there have been several LTAF launches from some household names in asset management, and we see these vehicles as representing a key growth area.
But for asset managers to be successful in servicing the DC market there are challenges to overcome.
Working with retail investors means more stringent reporting and transparency requirements. Meanwhile there are greater administration complexities and higher due diligence demands.
For example, only a full scope alternative investment fund manager can run an LTAF.
They must have proven knowledge, skills and experience – to understand the risk and assets of the LTAF. The manager must also employ sufficient personnel with relevant skills, knowledge and experience.
JTC provides a wide range of services that can support asset managers in setting up and operating an LTAF on an ongoing basis, and working with providers to ensure they can deliver excellence to all investor bases.
To find out more contact: Will Turner and Simon Gordon
[1] https://www.pwc.co.uk/pensions/pdf/pension-de-risking-part-1-of-3.pdf
[2] https://group.legalandgeneral.com/en/newsroom/press-releases/53-of-large-uk-defined-benefit-schemes-targeting-buy-in-or-buyout
[3] https://www.fitchratings.com/research/fund-asset-managers/uk-property-fund-redemption-demand-exposes-liquidity-mismatches-10-10-2022
[5] https://www.gov.uk/government/consultations/broadening-the-investment-opportunities-of-defined-contribution-pension-schemes/outcome/government-response-broadening-the-investment-opportunities-of-defined-contribution-pension-schemes#:~:text=DC%20pension%20schemes%20can%20afford,that%20balances%20risk%20and%20opportunity.
