Pension schemes are holding far too many liquid assets at the risk of giving up important returns needed to close funding gaps, according to Cambridge Associates.
Research by the consultant found in order to pay member benefits schemes only need to hold between 5% and 10% in liquid assets rather than the 90% to 95% they typically do at present.
It said this is because by holding such a high allocation of liquid assets schemes are giving up return opportunities needed to close funding gaps.
These gaps could be improved if schemes switched to illiquid private investments – a move which would also reduce the dependence on additional sponsor contributions, it added.
According to Pension Protection Fund data, the average UK scheme is just 77.5% funded. The funding gap has widened because low interest rates have increased the value of liabilities, despite the value of growth assets such as equities increasing over the past five years.
Cambridge Associates said a typical scheme has some 40% of liquid assets in liability-matching assets such as gilts and around 60% in growth assets such as equities and credit. Of that 60%, it said only 5-10% is invested in illiquid assets such as real estate, private equity, private credit and venture capital.
The consultant argued as schemes de-risk by buying more liability-matching assets and selling volatile assets, their ability to plug funding gaps reduces which increases the likelihood of depending on the sponsor for a capital injection.
The solution, according to Cambridge Associates, is a ‘barbell approach’ targeting substantially higher returns in a small part of the portfolio, for example 20%, using private, illiquid investments. The rest of the portfolio – as much as 80% – can then be focused on gilts and other liability-matching assets in order to reduce liability risk.
Cambridge Associates senior investment director Himanshu Chaturvedi said: “This approach to pension investing can deliver a hat-trick of benefits: plenty of liquidity, reduced volatility and appropriate rates of return to close the current funding gap.”
The Church of England Pensions Board (CEPB) recently spoke to portfolio institutional about its move into illiquid, private market assets, including US corporate loans and infrastructure. The fund is targeting a 30-35% allocation to illiquid assets within the next two-to-three years.
CEPB CIO Pierre Jameson said: “One of the reasons is to try to play the illiquidity premium more because our main scheme (for the clergy) is relatively immature, it’s still open and still enjoying new money and it has fairly long-duration liabilities. We believe something like 15% of our investments are ‘illiquid’ and a lot of the things we’re looking to do will take us more towards 30-35%.”
