Cash flow aware investment
Illiquid assets with regular and reliable income and the scope for capital appreciation would appear to offer defined benefit funds the best of both worlds. The returns from infrastructure, property and private debt are often inflation linked, they can be a fair match for liabilities and can give defined benefit funds the scope to own risky assets for longer. And while returns on such assets have declined with their popularity, their yields are still relatively high.
Here are several considerations for trustees of defined benefit plans in owning them.
Portfolio overview
"Private debt has been used extensively in the US for ten years, but less so in Europe which would appear to present a short-term opportunity for investors."
Firstly, tying up assets in less liquid form limits flexibility if a fund gets a recapitalisation call from their LDI manager. So, investors need to be aware of how illiquid assets will fit in their portfolios and which assets they sell to make room for them.
Owning directly or indirectly?
Secondly, investors should consider whether they want to own illiquid assets on a direct basis, which can involve greater governance, or on an indirect basis through a pooled fund. Also should investors consider if they want to hold them in a multi-asset fund or a more concentrated pooled fund.
Time-line
Thirdly, they also need to consider the time horizon for holding them.
Private debt
Beyond infrastructure and property, one of the most popular strategies is private debt. This is a way of capital raising for borrowers that can be easier than issuing a corporate bond. Investors should be aware that they are in a riskier position on such deals, as they will have to negotiate the security for the covenants to the debt, unlike corporate bonds.
Private debt has been used extensively in the US for ten years, but less so in Europe which would appear to present a short-term opportunity for investors. Here we would recommend multi-asset credit funds, as individual managers may not have a steady flow of deals to source. This is a format that is easily investable by pension funds and can offer returns of 5 percent.
Another form of illiquid investment is asset backed securities. Like infrastructure, this is best invested through a pooled fund except for the very largest pension funds.
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