Much illiquidity, but no premium

International best practice shows that DC funds with illiquid assets outperform in general. Daily pricing means UK funds do not benefit as much, but the industry has several initiatives to fix this. David Rowley reports.

In Australia, once a quarter, a Melbourne-based organisation called Industry Super Australia puts out a crowing press statement telling how industry superannuation funds have outperformed their peers.

This September, the difference in returns between industry funds and bank-owned retail funds was 2.2% over 10 years, 2% over seven years, 1.8% over five years, 2.2% over three years, and 2.67% over one year. It’s a crushing victory and one of the biggest reasons is allocations to illiquid assets of  between 20-30%. Having a captive audience of employers who default their members  into a fund relative to their trade or industry gives a stable membership, allowing industry funds to take the risk of owning more illiquid assets. If that membership is predominantly young, then the allocations can go even higher. This is true of Hostplus, the AU$20bn industry super fund that accumulates retirement savings for Australians who work in hospitality, tourism,  recreation and sport. Its default fund has 60% in equities, 15% in property, 10% in infrastructure, 5% in private equity with the remaining 10% in a mixture of cash, fixed interest and alternatives. Unlike the average UK defined contribution (DC) fund, most of its property and infrastructure is directly owned in co-investments with other large institutional investors. It also has an in-house private equity specialist who monitors the allocations and relationships with fund managers. To the end of June 2016, Hostplus delivered returns of 9.23% over five years. There is a similar picture coming from the US too. In February 2016, Cambridge Associates published a survey of 453 university, college and foundation endowments in the US. The report stated: “Endowment portfolios with more than 15% allocated to private investments have outperformed their peers consistently, and for decades.”UK INITIATIVES These tales from overseas are  inspiring a host of new initiatives to raise the proportion of illiquid assets invested by UK DC funds. There is an Investment Association report which will be produced by a working group of prominent fund managers in the first quarter of 2017. There is also a working party at the Institute and Faculty of  Actuaries looking into it. The problem is that most UK DC funds access illiquid assets through a life insurance platform which needs to be ‘life wrapped’ to create a mirror unit-linked policy. This means adhering to an automated trading system and daily trading which does not favour allocations to illiquids. So, typically illiquid assets are accessed through daily-priced investment trusts within diversified growth funds (DGFs). To what extent these access the full illiquidity premium enjoyed by funds in Australia and the US is a moot point. Catherine Doyle, head of  defined contribution at Newton Investment Management, says DGFs are good for diversification of returns, but not for accessing the full illiquidity premium. “There is a realisation that it is not necessarily the best way of capturing the premium of these asset classes as you do not have the full economic exposure. In an i deal world, you would not be forced into that straitjacket of daily liquidity.”