Keeping members at the heart of schemes and ensuring value for money (VFM) within investments mean plans to increase UK DC schemes’ exposure to illiquids are “not going to be straightforward”, Aviva Investors senior client solutions director, Heather Brown, has said.

Speaking to our sister publication European Pensions, Brown discussed the opportunities and challenges of DC schemes investing in illiquids. There is currently a push from the UK government for DC schemes to increase their exposure to illiquid investments, with the hope of using the country’s pension savings to boost UK industry.

Chancellor, Jeremy Hunt, announced the Mansion House reforms in July. As part of this, several of the UK’s largest DC pension providers, including Aviva, have voluntarily pledged to allocate 5 per cent of assets in their default funds to unlisted equities by 2030; this new agreement is known as the Mansion House Compact.

This will see more investments into private equity such as venture capital. While there will be opportunities to invest in new technologies, making it politically attractive, Brown explained how member outcomes must be kept in mind.

“Private markets can be seen as an enabler of the climate transition. For example, investing in new technologies that can potentially deliver, because all these ideas like electric vehicle (EV) charging or carbon capture come from small ideas through venture capital. You can see why there is more interest in bringing the agenda forward," she said.

“It's an interesting space, but I think most of all, and where all the debate is amongst the pensions industry, is bringing it all back so that there is a focus on member outcomes, a focus on diversification – on risk and reward but also importantly VFM. Keeping that at the heart means that it's not going to be straightforward.”

Over the past several years there has been a lot of talk on how the industry can make illiquids work for DC pensions. Aviva Investors was part of the Productive Finance Working Group, along with other industry participants, which aimed to come up with solutions on a regime or structure that would allow DC schemes to “move away from some of the challenges and pitfalls that we’ve seen before and invest in long-term less liquid assets”.

“We've done a lot of talking about the case for illiquids in DC, in terms of diversification, in terms of returns, in terms of the ability to take advantage of themes, such as climate. By that, I mean new technologies or new infrastructure. We've done a lot of talking about the case for it and I think investment consultants have also been making the case for it, so let’s get beyond the case and let's put it into practice,” Brown said.

In terms of climate transition opportunities within illiquids, Brown believes they can be found in real estate, but in a structure that isn’t a daily-dealt property fund, such as a fund created under the new Long Term Asset Fund regime. There is also the prospect of helping the climate transition in terms of converting existing ‘brown’ buildings and making them ‘green’ buildings.

“That’s a decision in real estate; do I build a new best-in-class super energy efficient [building] or do I take an existing building and make it more energy efficient, because 70 to 80 per cent of existing buildings will still be here in 2050 when we are meant to have reached our net zero target,” she said.

Infrastructure equity, such as EV charging, fibre broadband, wind and renewables, are also up for the taking, as are nature-based solutions like forestry, which can all help achieve the 2050 net zero target.

When it comes to the fee cap on DC schemes, which stands at 75 basis points for the default strategy, Brown believes illiquids are “absolutely” achievable. Currently many of the big master trusts have investment fees of around 10-15 basis points and the industry has questioned whether organisations are willing to pay more.

“To make an allocation that you might start to become comfortable with, in terms of these types of assets, schemes might be looking at 10 per cent, perhaps 15 per cent, but even so, it's still doable within the fee cap, but are organisations willing to pay more when selecting their pension provider?,” she questioned.

“We can talk about VFM and what we think it represents but are people willing to pay the extra…. it's how as an industry we get beyond.”

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