Illiquid assets- diversifying and managing risk through the retirement journey

Diversification and managing risk throughout the retirement journey play a central role in our default solutions.

More specifically, our solutions invest across traditional asset classes, namely equities and bonds, as well as alternative investments such as direct commercial property. With regard to risk, we want to ensure that the amount of risk customers are exposed to is compatible with their position in the retirement journey.

With this in mind, we regularly review the composition of our proposition to amend and finetune our default solutions as part of our structured governance process in response to changes in the financial markets and also regulation.

Our ultimate objective is for our default solutions to help deliver positive outcomes for our customers in retirement.

We therefore welcome the industry interest in illiquid assets and how investing in this asset class will help improve outcomes for pension scheme members. We believe that any extra member costs will be offset by the potential for stronger risk-adjusted long-term performance.

Where does the industry stand?

In a recent report, the Pension and Lifetime Savings Association (PLSA) reminded the industry that pension funds and illiquid assets have a long history with workplace pension funds already investing in infrastructure, toll roads and clean energy. In its report, the pensions body said: 

Pension funds will always be interested in exploring investments which have a strong likelihood of generating good returns, within their risk tolerances, and in the interests of their respective members.

The Mansion House Compact has focused the industry’s attention on diversification and the opportunity other asset classes can provide. Many of the UK’s leading pension providers have voluntarily pledged to invest 5% of assets in their default funds to unlisted equities by 2030. The agreement has the potential to open up more opportunities in private equity investments as well as help new and innovative UK and global businesses to realise their potential more quickly. Investment in private equity, in line with the Mansion House Compact, is a natural next step for us.

Current trends and keeping up with inflation

The upheaval in markets over the past three years also showed why looking beyond the traditional asset class opportunity set is so important. The Covid-19 crisis, the persistent rise in inflation and the breakdown in the traditional correlations between equities and bonds in 2022 have reinforced the need for DC scheme providers to take a closer look at non-traditional asset classes. Illiquid investments can work alongside equities and bonds in a multi-asset solution thanks to their reliable multi-year income streams and long-term investment horizons.  Inflation is another important factor here and the need to invest in assets that can keep pace with inflation and help protect customers’ savings from inflation over the longer term.

Our illiquid assets journey

We’ve been on our own illiquid assets journey for more than a decade. Recognising the diversification benefits of alternative assets, we’ve held a sizeable allocation of 10% in commercial property since early 2013 in the growth stage of our default solution, and a smaller position in the retirement stage.

We like the attractive yields available in this space and the potential for long-term capital growth that we believe we’re well placed to capture thanks to a well-established and well-resourced real assets team within our in-house asset manager, Aviva Investors. This has given us the scale and expertise to source good quality investments for our default solutions from across the commercial property market. It’s these resources, as well as the breadth of expertise across our other strategic investment manager partners, that we will continue to tap into to enable us to build the bridge between our default solutions and less traditional assets.

Taking our illiquid asset investments further

Over the past few years, we’ve spent time exploring how we can take our investment in illiquid assets in our flagship default solutions further.  In particular, we have been exploring the inclusion of private debt, once again by leveraging Aviva Investors’ experienced team. Speaking about pension funds and illiquid assets, Luke Layfield co-Portfolio Manager of the Aviva Investors Climate Transition Real Assets Fund, said: 

The focus of the initiative (for Aviva Investors) is venture capital at this stage, but it shows the direction of travel and an attempt to broaden the types of investments DC schemes make. DC schemes are also showing increasing interest in real assets, as they see an opportunity to boost returns and improve diversification while also delivering broader environmental, social and governance (ESG) outcomes.

This aligns with our belief that pension funds have a central role to play in the transition to a greener future. By investing in nascent, high growth industries, such as solar energy, we believe that pension funds can broaden their asset class horizon, provide better long term outcomes for their members and also lead in the transition to cleaner industries for the future of the planet and the economy. This includes customers saving for retirement and those post-retirement, which is why we’ve included the Aviva Investors Climate Transition Fund in our Guided Retirement solution.  Adding impact funds is a way for us to add less traditional assets to our solutions while at the same time helping with the transition to net zero, and as mentioned tapping into the rich resources and management capabilities of our fund manager partners.

This is an exciting time for workplace pensions – we believe that the appetite in the industry for greater diversification in a risk-aware manner is to be welcomed.  The greater the opportunity-set pension scheme members have,  the greater the potential we believe we will have to help members achieve financial security in retirement.