The current chancellor of the exchequer fired the starting gun on the rush to illiquids last summer, with a Mansion House speech that announced that he had signed up many of our largest and most successful pension providers to a ‘compact’ to invest 5 per cent of their default funds into unlisted equities.
Sensing a win-win situation, Jeremy Hunt predicted that he would unlock up to £50bn of new investment funding for Britain’s young high-growth companies, while at the same time boosting pension pots by 12 per cent, adding £1,000 to the annual retirement incomes of average savers, and of course much more than that for higher earners.
It seems that for the past two decades the desire to diversify portfolios has sent so much of our own pension money offshore to emerging markets – to the Brics, Civets and other regions – so that foreign investors are rapidly becoming the only ones funding much of our infrastructure investment and young company growth.
So, the drive to increase pension holdings in commercial property, private equity, green energy projects and un-listed shares is on.
For those now considering adding illiquids to clients’ portfolios, I offer you three golden rules to make the most of these exciting opportunities and boost the growth prospects of a client’s portfolio without going too far out on a limb.
Rule #1: Line up investment payouts with client’s intended cash flows
Illiquids should be regarded as long-term investments. However, look through the customary Financial Conduct Authority warnings for clients around ‘it’s a long term investment’ because what an actuary hears from this statement is that much of the value of this investment is going to be in the yearly cash flows it generates rather than a payout at the end.
You will see examples of this today with infrastructure stocks and venture capital trusts, which generate high levels of annual dividends.
To meet my first golden rule, choose illiquids that are expected to generate a natural income that meets client’s cash flow requirements.
If they are not yet retired, you could select early stage private equity funds in which your investments only bear fruit after some years of the manager seeking out targets, deploying funds, improving companies, and only later taking profits.
However, for an active early retiree gallivanting through their free time, buying into infrastructure projects that have already completed their build stage can generate an immediate flow of income that will automatically adjust upwards with inflation so a client’s retirement income can keep pace with the increasing cost of living.
Rule #2: Listen to what the market is telling you
This is where illiquids are very different to securities like shares or bonds listed on the world’s major stock markets. Those listed securities will behave in a rational way.
Several platforms now produce market commentary at lunchtime or close of business that explain that prices went up or down in reaction to the latest release of inflation, employment figures, or interest rate data.
Stockbrokers will publish buy/sell/hold recommendations along with a target price that they expect a share to move to in the near future as investors appreciate something the stockbroker has spotted. It is all very logical.
