Without significant changes to the regulatory and operating framework around DC schemes in the UK, many of the barriers to investing in illiquid funds will remain, writes Philip Smith, DC director at TPT Retirement Solutions. 

The illiquid dream for defined contribution (DC) schemes in the UK is far from realised and will remain that way until there is a fundamental shift in the make-up of the industry’s infrastructure and regulation that underpins it.

Boris Johnson’s ‘build, build, build’ speech placed a great importance on the role of infrastructure in rebuilding the economy post-pandemic. This infrastructure boom will require major investment from both the government and the private sector.

One of the main arguments for pension schemes to be invested in illiquid assets is that it not only helps unlock private capital to fund major infrastructure projects but it also diversifies a scheme portfolio and provides long-term equity like returns for investors.

However, the UK’s DC pension schemes are unlikely to be able to help bridge that gap, at least in the short-term. The country’s DC assets remain divided between contract-based group personal pensions and occupational trust-based arrangements, both subject to different regulatory regimes. The individual contract-based nature of a personal pension, regulated by the Financial Conduct Authority (FCA), means that long-term illiquid investing is inaccessible to the vast majority of members, and costly and impractical for product providers to implement.

The occupational trust-based market, regulated by The Pensions Regulator (TPR), also remains fragmented, with TPR’s scheme return data for 2018-2019 showing 31,910 occupational schemes with two or more DC members and total asset values at £60bn (€65bn).

Building scale

There are however, encouraging signs that the market is beginning to consolidate and build the necessary scale, with newly authorised master trusts leading the way. More and more employers are deciding that running their own DC scheme is not an effective use of resources and are turning to the master trust market, which is also seeing exponential growth driven by auto-enrolment.

Membership in master trusts has increased from 270,000 at the beginning of 2012 to just over 13.9 million in 2019.

Nevertheless, scale and industry infrastructure remain the key issues, with the majority of master trusts yet to reach the level of assets under management required to make investing in long-term illiquid assets viable.

The government and regulators recognise the benefits of unlocking pension scheme assets to help fund crucial infrastructure projects, and some of the regulation that previously held up schemes from investing in this area has been removed or is in the process of being changed.

The Patient Capital review was central to this and has led to much of the change. Factors such as the permitted links rules that were a barrier have since been changed by the FCA. Despite this, the DC industry is not well placed to invest in the typical contractual structures that are often used in infrastructure investment. These types of products have been developed for DB investors with long time horizons, no need for daily dealing and no charge cap to contend with.

Phil Smith High Res

“For now, it is only the largest master trusts that have the scale to begin moving away from the life company model”

Philip Smith, DC Director at TPT Retirement Solutions


Existing DC investment systems have a deep-rooted life company heritage, with the vast majority of assets still sitting on life company platforms in wrapped funds or UCITS. Moving away from this structure requires considerable scale and sophisticated back office infrastructure to value the illiquid assets and manage daily liquidity requirements.

The availability of private market DC pooled funds that can be used by this infrastructure is currently limited, and adoption by UK schemes has been slow. With average master trust annual management fees sitting between 0.38%-0.50% according to DWP figures, incorporating these vehicles is always going to be challenging.

For now, it is only the largest master trusts that have the scale to begin moving away from the life company model, working alongside their custodians to build the necessary systems and processes to allow investment in private markets and illiquid assets.

Outlook positive?

NEST has led the way and in 2019 it announced three investments into illiquid private debt markets, working with its appointed investment managers to ensure sufficient flexibility in the frequency of valuation. As the market reaches sufficient scale others will doubtless follow, offering their members the potential benefits of the illiquidity premium at a price point that can be made to work within the charge cap.

It is instructive to look at other countries’ approaches to unlocking greater illiquid investing from pension schemes. In particular, the US and Australia offer models the UK regulators could look to incorporate as part of their reforms. In the US, the regulator has recently opened up the 401k market to investing in private equity, while more mature DC markets like Australia’s superannuation schemes can have as much as 30% allocated towards illiquid investments.

Until we see significant changes to the regulatory and operating framework around DC schemes in the UK many of the barriers to investing in illiquid funds will remain.

While assets are growing at an exponential rate, we still have not truly seen the scale required for funds outside of the trust-based model to achieve the required assets under management to be able to allocate funds towards illiquids. However, given the political focus and change of pace the industry has undergone over the last 10 years it may not be long until DC funds are in a better position to allocate to this valuable asset class.

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