UK: Lessons Learned From Developing WTW's Long Term Asset Fund (LTAF)

LTAFs offer a new way to access illiquid assets. What have we learned in the process of launching one? And how can DC schemes navigate this brave new world on behalf of scheme members?

Why invest in productive finance?

Productive finance assets are severely underrepresented in the portfolios of UK Defined Contribution (DC) pension investors. Yet UK DC DC assets under management are growing incredibly fast, and DC scheme savers are true long-term investors. Time horizons longer than 30 years on average create opportunities to invest in less liquid asset classes.

Productive finance assets offer huge diversification benefits compared to traditional asset classes. With long term structural changes shaking up society and challenging developed economies, many private market assets stand to benefit where publicly listed assets may falter.

Some of the world's most innovative and fast-growing companies, in areas like digitisation, automation, and technology linked to the climate transition, are private. DC schemes which only invest in listed companies risk missing out on a wider range of opportunities and crucially, the potential to improve investment returns for savers.

Pension scheme fiduciaries in other countries recognise the many opportunities which private markets offer DC savers. In Australia, 20% of superannuation funds are invested in private assets; in the Netherlands, it's seven percent. The average UK DC saver's allocation is much lower, at 0.5 percent on average.

UK DC savers are at risk of ending up the poor relation, compared to their counterparts around the world. Thankfully, this is a well-recognised problem, and the UK pensions industry, government and regulators are implementing several strategies to improve DC savers' access to productive finance.

One such strategy is the launch of Long Term Asset Funds (LTAFs). For the first time, there is a specific vehicle, authorised by the Financial Conduct Authority, which has strong governance and investor protection at its core. Having a new fund structure is not a panacea in itself, but it is an important step in the right direction.

Excitingly, at WTW, we are launching our own LTAF¹. Here are three important lessons we learned while developing our own LTAF and evaluating the handful of others which are currently on the market – as well as some advice on what DC schemes need to think about when investing in less liquid asset classes.

Lesson one: a mindset shift on pricing is needed

Private market assets are not traded and priced daily on exchanges, which means the availability of valuations will not be daily, which DC pension schemes usually require.

A mindset shift is needed. Part of the attraction of owning these assets is their private nature, which gives owners and managers the ability to create value and implement growth strategies away from the pressure of quarterly earnings calls. By its nature, this is part of what helps drive returns.

Having a daily price that is reflective of all the information available at any point in time is unrealistic. However, schemes and their advisers shouldn't accept prices that remain stale for a long period of time.

Lesson two: establish a robust valuation policy

LTAFs must, by definition, have a robust valuations policy. The challenge is establishing the value of the underlying assets.

We believe that the best approach is to combine in house experience and skills with an independent third-party valuation agent. We expect that this will become best practice in the market.

Having independent assessment and challenge will ensure that members are treated fairly as they transition their money in and out of long-term assets.

Lesson three: fairness

Liquidity should be carefully considered. The liquidity terms of the LTAF need to appropriately align with the strategy that any LTAF is implementing. We must ensure the strategy is well matched with the vehicle's underlying assets.

Our view is LTAFs should not be stretching themselves to be as liquid as the regulations allow for, just for commercial reasons. They must understand the portfolio liquidity risks they have to manage and ensure that, when investors come knocking, they can deliver the liquidity they promised.

Navigating the opportunities as a DC trustee

With such a broad opportunity set on offer, making the right allocation to productive finance can feel overwhelming.

DC trustees should put risk management at the front of their minds. Different members will have different requirements. Whether members are in the growth phase, mid-career or pre-retirement, trustees must ensure appropriate levels of risk are factored in.

For example, in the growth phase, trustees may wish to consider allocations to asset classes with higher risk and higher reward profiles, such as private equity or venture capital. During mid-career, infrastructure could be worth considering. On the approach to retirement, asset classes like private credit or secure income are likely to give members more protection. As ever, a selective approach within these asset classes will be key.

Footnote

1. This is subject to regulatory approval, which is anticipated in the second quarter of 2024. Return to article undo

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