UK pension funds rush to ditch unlisted assets as regulators question valuations

UK pension funds are rushing to sell unlisted assets – often at a discount – because they are overexposed to the opaque $12 trillion global private market as regulators question the true value of investments spanning property to private equity, industry sources say.

Global watchdogs are raising the alarm about the value of so-called private market assets, including big infrastructure projects, the paper worth of which has yet to be adjusted downwards while listed markets, such as bonds, have suffered an historic rout due to higher borrowing costs.

One sector feeling the impact of owning hard-to-value illiquid investments as financial conditions tighten is the 1.5 trillion pound ($1.8 trillion) defined benefit, or final salary, pension fund industry – which drove a UK market sell-off a year ago.

These pension providers, which pledge guaranteed incomes to retirees from the public sector and some private companies, are selling office blocks and private equity stakes at hefty discounts to the value marked on their books, according to several people working in the sector.

Britain’s Financial Conduct Authority is one regulator which is growing uneasy about the market. It is preparing a review of how private asset valuations are conducted, including whether any risks of over-valuation could have a knock-on impact on banks – the central pillars of the financial system.

Such assets have become tricky to price, particularly in real estate where commercial transactions have slumped.

“There’s been very little marking down of (private) assets,” said Con Keating, head of research at Brighton Rock Group, an insurance company for pension schemes. “It’s cloud cuckoo accounting.”

Final salary retirement schemes ran into trouble a year ago after a surge in government bond yields left them scrambling for cash to cover margin calls on derivatives – financial bets they had placed to cover pension obligations assuming a relatively stable low-yielding bond market.

As bond yields close in on levels pension funds were accustomed to before the global financial crisis, their overexposure to illiquid assets could leave them short of ready cash in another crisis, industry sources say. Sales of these assets at discounts also dent their funding positions, they added.

“No-one knows where the next big blow-up for pensions will come from,” said Henry Tapper, founder of pension market analysis group AgeWage.

“But we are unsure about private market valuations.”

 

RUSHING OUT

UK final salary pension funds are selling illiquid assets at discounts of as much as 40 per cent to the values they held them at on their books, EY’s UK head of pensions consulting Paul Kitson said.

He said heavy selling of commercial property and private equity stakes by pension schemes is raising questions over private capital valuations.

Property markets in Germany and Sweden, for instance, have come under severe pressure, while London office vacancies are at a three decade high. Yet an index of global real estate fund returns produced by Burgiss declined by just 0.7 per cent in the quarter to June.

“The real estate market is depressed,” said Ben Leach, head of private markets solutions at investment consultant Willis Towers Watson, adding that pension funds were selling office buildings at 35 per cent discounts.

“It’s the right approach to obviously put some scrutiny on private market valuations.”

Global securities regulator IOSCO said in a report last month that such valuations were “inevitably stale”, with many private funds valuing assets only quarterly, or even annually, compared with many times a minute for listed securities.

 

PRIVATE EQUITY

Real estate is not the only sector under scrutiny.

The Burgiss index of private equity buyout performance, which measures cash generated and value, shows global managers of these funds reported a 2.8 per cent gain in both the first and second quarters of 2023.

But in deals where private equity firms and investors buy and sell portfolios of investments, assets are being valued at less.

Wilfred Small, senior managing director at private equity house Ardian, said stakes in buyout funds have been selling at around 85 cents on the dollar in the secondary market since “early 2022”, when central banks began raising rates, with sellers accepting discounts in return for liquidity.

UK-listed investment trusts that hold private equity portfolios are trading at a larger 27 per cent discount on average to the net asset values they report for their portfolios, according to Numis Securities.

The average discount across the investment trust sector is 15 per cent.

($1 = 0.8196 pounds)