Access to a wider universe of investments through alternatives is an “important and growing fundamental trend” for pension investment, with changes in the market set to release new sources of funds, according to research from the Pensions Policy Institute (PPI).
The PPI’s research, sponsored by the World Gold Council, found that changes in both the defined benefit (DB) and defined contribution (DC) pensions markets are promising to release new sources of funds for long-term investment over the short to medium term.
Whilst much of these funds will still be invested in traditional public markets, the PPI said that alternative investments have the potential to grow in scale and to deliver improved outcomes for members.
“The use of alternative assets in pension funds is a topical subject and there is evidence of significant change both in asset markets and pension scheme asset allocation to play out over the medium term,” the PPI found.
In particular, the PPI said that DB can expect a growth in the use of alternatives, especially to generate long-term secure incomes for members.
The PPI noted that, for open DB schemes, alternatives are already an established part of the asset allocation, and there still may be some expectation that this will increase, for example in Local Government Pension Scheme (LGPS) funds.
However, it pointed out that there also appears to be a period of transition for closed DB schemes, accelerated by the marked recovery of solvency positions in the last couple of years.
“On the one hand, the majority of trustees targeting buyout will seek to divest their schemes of any remaining alternatives assets in preparation for a buyout transaction with a specialist insurer,” the PPI said.
“However, once the liabilities are assumed by these insurers, it is expected that a significant minority of the assets acquired will be invested in alternatives, particular private credit and infrastructure, to match their long-term annuity-like liabilities.”
Given this, the PPI admitted that the speed of this transition will be heavily influenced by the capacity of the bulk buyout market to take on these new schemes and assets.
However, it pointed out that there are other trustees who are re-examining their run-off strategies and may choose to use their improved solvency positions to manage run-off themselves to extract additional value for members and potentially shareholders.
“If they adopt this strategy, we could expect them to increase their investment in alternatives, both to match the need to pay retirement incomes and, to a lesser extent, provide some growth opportunity,” it stated.
The PPI said that there are also emerging opportunities to deploy alternative investments in workplace DC schemes, albeit from a lower base, noting that DC schemes are set to grow fast, with the majority of new member contributions directed to DC schemes.
“These opportunities are supported by the consolidation of workplace DC schemes to achieve economic scale, encouraged in part by government and regulatory policy,” the PPI stated. “There is also a very high concentration of investment by members within these schemes into the default fund arrangements.
“For those DC members in master trusts, the achievement of scale promises growing access to alternative investments reflecting the quality and diversification of investment solutions enjoyed by members of large open DB schemes.”
However, the PPI said the speed and extent of expansion is likely to be determined by a number of factors, including the ability of DC master trusts to develop the skills to manage and oversee a wider range of investments, the success of asset managers to offer pooled alternative investment funds at charge levels that trustees consider will offer value for money, and the speed of consolidation with the master trust sector.
The PPI also clarified that this is only relevant to the 25 per cent of DC assets currently in trust-based arrangements.
“For the 75 per cent still in contract-based arrangements, little change can be expected unless the trust-based sector has significant success in securing the inward transfer of existing contract-based arrangements,” it acknowledged.