Melville Rodrigues

Melville Rodrigues is head of real estate advisory at Apex Group

With the economic environment becoming more challenging, the need for UK defined contribution (DC) pension schemes to pursue greater diversification is pressing. UK pension schemes are lagging behind other developed economies in the context of investing in alternatives – that is, longer-term, less liquid assets such as real estate, infrastructure, private equity and venture capital. The seven largest pension markets globally allocate on average 19% to illiquid assets, an increase from 7% in 2000, whereas UK pension allocations remain flat at about 7% to 8%.

British pension holders are missing out. A 2019 study, co-authored by the British Business Bank and Oliver Wyman with a remit from the Treasury, estimated that an average 22-year-old new entrant to a default DC scheme with a 5% allocation to venture capital or growth equity could achieve a 7% to 12% increase in retirement savings.

As the need for investors to decorrelate their portfolios from equities and bonds grows, UK DC schemes must explore new opportunities to progress their investments in alternative asset classes and achieve better returns for their members.

The trustees of (and consultants to) each DC scheme should consider greater allocation to alternatives, given the trustees’ fiduciary duty to improve outcomes for pension holders. When a DC scheme commits to alternatives, it swaps the traditional liquid assets (like equities and bonds) for a product on an illiquidity spectrum. Therefore, the scheme needs to evaluate the consequences of that illiquidity and the strategic implications. DC commitments, of course, can be into direct or indirect alternatives – with the prospects of the latter offering an opportunity for liquidity at the indirect vehicle level.

The scope for liquidity (and associated) trade-offs is assessed below in pursuing an indirect alternatives strategy through the following two UK vehicles:

  • a listed investment company (LIC), which is currently available;
  • an open-ended long-term asset fund (LTAF).

The LTAF rules were implemented in November 2021, with a view to attracting DC investors. However, the Financial Conduct Authority (FCA) has still not received, as at this month, any formal LTAF applications. That said, prospective manager applicants have identified pipeline assets and progressed discussions with the FCA about launching LTAFs.

In relation to these vehicles, features relating to the underlying vehicle assets (for example, scale and nature of those assets) will also be relevant in assessing liquidity. Furthermore, any assessment from a DC perspective must recognise important cost, consolidation and other drivers challenging the DC market.

DC challenges

In September 2021, the Productive Finance Working Group (PFWG), a group convened by the Bank of England, FCA and Treasury, helpfully summarised the cost and consolidation challenges faced by the DC industry in a roadmap report:

“As the DC pension industry has grown, it has sought to ensure that costs to investors are kept low, supported by the implementation of the Department for Work and Pensions (DWP) charge cap, among other things. This was necessary against a backdrop of legacy products that had relatively high costs without necessarily generating sufficient value for members. However, as DC provision expands, an excessive focus on cost alone could result in investments, potentially providing better value for money, being overlooked – to the detriment of savers.

“To shift the focus from cost to long-term value and improve member outcomes as the industry grows, we recommend DC scheme decision-makers (including trustees) and consultants actively consider how increasing investment in less liquid assets could generate better value for their members… The UK DC market is characterised by a long tail of small schemes, which make longer-term investments less accessible for the majority of the market. These schemes are a key reason why a continued focus on cost has been necessary and could explain why investment by DC schemes in longer term assets is lower, compared to DB schemes and some other jurisdictions.

“To address the barriers from this lack of scale, DWP should continue with a DC schemes consolidation agenda where it is clear that schemes are not providing value for members. DC schemes, themselves, should consider whether their scale is a barrier to good member outcomes including to the potential benefits of greater investment in less liquid assets”.

Bank of England’s A roadmap for increasing productive finance investment

On the face of it, DC schemes’ capacity to progress indirect alternatives strategies may be delayed until there is more scheme consolidation. Interestingly, there could be a complementary driver, which is DC scheme assets are expected to continue increasing at a staggering pace. The FCA stated in its May 2021 consultation paper on LTAFs that DC pension assets have risen by approximately £120bn (€140bn) in four years to £460bn in 2019 and are expected to rise to over £1trn by 2030.

DC scheme projected asset growth and resultant opportunities for economies of scale and other efficiencies may facilitate DC scheme consolidation (similar to that being experienced with UK local authority pension schemes and pooling).

In addition, DC schemes need to address other regulatory challenges that include ESG and net-zero compliance, as well as the DWP taking the lead with:

  • Charge cap reforms to better accommodate well-designed performance fees” (also supported by the PFWG). This will hopefully contribute to overcoming the impasse whereby DC schemes are averse to paying performance fees. In contrast, alternative fund managers (working within risk-return dynamics) are incentivised by fees that reflect returns in excess of a base management fee and represent an alignment of interest between investors and managers.
  • New rules on asset allocation and past performance disclosures that will bring greater scrutiny on the design of DC investment strategies. Such strategies are expected to be an increasing source of differentiation.

The combination of these regulatory drivers, as well as more immediate market challenges associated with geopolitics and inflation, may explain the attention of DC trustee and consultants being diverted with short-term priorities. However, as DC schemes develop medium-to-long-term strategies they should consider options via indirect alternatives, including LIC shares and (when available) LTAF units and pragmatic liquidity solutions by reason of the vehicles.


The shares in these closed-ended investment companies are listed and can be daily traded. They include investment trusts and listed real estate investment trusts. The LICs could be considered attractive in addressing important liquidity DC benchmarks, including:

  • achieving automatic rebalancing within DC default strategies;
  • scheme member expectation of daily pricing and flexibility to switch;
  • for people aged over 55, capacity to access pensions.

However, LICs are by no means a panacea and came with questions for investors:

  • Do they represent a credible decorrelation from equities and management of the net asset value (NAV) discount and volatility risks, given LIC shares are listed? As such, do LICs actually provide a true alternatives exposure?
  • Are they restricted from a supply perspective. Managers operating within the alternatives sector tend to operate private unlisted funds that are considered more suited to long-term, patient capital, and thereby avoid the risk of market pressure to pursue short-term investment strategies that influence listed share price movement.

Managers experience market challenges with new LIC listings of generalist/broadly-based alternative strategies on account of concerns like the NAV discount, albeit narrower specialist strategies can be received more favourably. This could lead to a mismatch between the supply of LICs and any likely emerging further DC demand for broadly-based alternatives exposure.


Given the illiquid nature of the assets (and mindful of the liquidity mismatch problem experienced with daily dealing funds holding real estate), the LTAF has not been designed as a daily-dealing fund – but it can support redemption of units based on NAV no more often than monthly and with a minimum notice period of at least 90 days. In the scenario that LTAFs were launched, service providers have infrastructure in place to assist managers in operating LTAFs.

This month, the FCA published a consultation paper on broadening retail access to LTAFs, with final rules expected in early 2023. The FCA is of the view that LTAF units should be re-categorised as a restricted mass market investment (RMMI) for retail distribution purposes. The RMMI re-categorisation of LTAF units gives managers the opportunity to diversify the LTAF’s investor DC pension scheme base – for example, with clients of wealth management houses.

There are also trade-offs associated with LTAFs that will need to be analysed on an individual basis, such as:

  • the length of notice periods (may be in excess of 90 days), to address liquidity matching;
  • redeeming investors will be paid based on a NAV price calculated at the end of the notice period, and run the risk of price adjustment during the redemption period;
  • how and when the LTAF will be rebalanced.

Investment platforms and distributors: an LTAF problem?

There also mixed views about whether the investment platforms and distributors that accommodate daily-dealing funds can justify the costs in adjusting their systems for LTAFs and other non-daily-dealing funds.

Platforms refer to those who facilitate retail access and others (associated with fund managers) who facilitate DC access. This problem of adjusting systems is surmountable. For instance, there may be synergies for each in adjusting systems. With the latter, the FCA estimates, in updating their IT systems, indicative one‑off per firm costs would be about £450,000 for large managers to £125,000 for medium managers.

Generational segmentation default focus

In terms of each DC scheme progressing indirect alternatives strategies, LICs and (when available) LTAFs, with scale that address DC liquidity benchmarks, would each offer pragmatic solutions. The approach adopted by the DC scheme should, of course, dovetail with different liquidity expectations associated with the age of pension holders: a 22-year-old new entrant contrasts with a 55-year-old in terms of likely duration for retirement and need to access the pension.

For instance, our younger generation is admirably supportive of levelling up, ESG and positive social impact agendas, and must be encouraged to save via pensions. In meeting the expectations of younger generation pension holders, DC schemes should aim to achieve long-term optimal returns that also endorse these agendas. The schemes could implement a generational segmentation default focus including an alternatives allocation through appropriate LICs and LTAFs.