As UK defined contribution (DC) schemes evolve, the need for diversified, resilient portfolios has never been greater. With traditional asset classes under pressure and member outcomes increasingly scrutinised, private markets are emerging as a compelling solution. Yet, integrating them into DC strategies requires careful planning, robust governance, and a clear understanding of the unique dynamics at play.
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Private markets offer the potential for enhanced long-term returns, inflation protection, and ESG alignment. But they also come with challenges: illiquidity, cash flow complexity, and performance dispersion. To navigate these, DC schemes must adopt a structured approach to portfolio construction that goes beyond simple asset allocation.
One of the most compelling reasons to consider private markets is their direct link to the real economy. Investing in infrastructure projects, sustainable housing, renewable energy, and growth-stage businesses means DC members’ savings are not just chasing returns – they’re helping build the future. This tangible connection can enhance member engagement and make the pension proposition more meaningful.
However, the dispersion of returns across private market segments is significant. Unlike listed markets, where performance tends to cluster, private markets show wide variability depending on manager skill, access route, and asset type. This makes manager selection critical. Schemes must look beyond headline IRRs and assess track records, deal attribution, and value creation strategies. Access routes – whether primary funds, secondaries, co-investments or direct investments – also influence outcomes and should be chosen based on scheme objectives, liquidity needs and cost envelope.
Cash management is another key consideration. Private markets require committed capital over multi-year horizons, with drawdowns and distributions occurring unpredictably. Poor cash management can lead to performance drag or forced selling of liquid assets. Schemes must model expected cash flows, maintain appropriate buffers, and consider fund financing tools. Open-ended structures like Long-Term Asset Funds (LTAFs) offer flexibility but demand rigorous liquidity oversight. The ability to stay invested while maintaining liquidity is essential to avoid diluting returns.
The “J-curve” effect, where early-stage investments show negative returns due to upfront costs and delayed value creation, is a structural feature of private markets. For DC schemes, where member fairness and sequencing risk are key, smoothing the return journey is essential. This can be achieved through diversification across asset classes and maturities, secondary market participation, and phased deployment. A well-designed pacing plan spreads commitments across vintage years and sectors, reducing exposure to single-cycle shocks and supporting long-term resilience.
As DC schemes increasingly adopt semi-liquid structures, the issue of intergenerational fairness becomes more prominent. Members enter and exit default funds at different times, and without careful design, they may be exposed to uneven cost and return profiles. For example, performance fees often accrue at the end of a fund’s life, potentially benefiting one cohort while disadvantaging another. To address this, schemes should consider mechanisms such as dilution levies, NAV-based accruals, and diversified J-curve profiles across the portfolio. These tools help ensure that costs and benefits are fairly distributed, supporting equitable outcomes for all members, regardless of when they join or leave.
Private markets also offer a powerful route to ESG and net zero alignment. With growing regulatory and member focus on sustainability, these investments can help schemes meet their climate goals. From renewable energy to green real estate, private markets enable targeted capital allocation to projects that drive real-world impact. However, data transparency remains a challenge. Schemes should engage with managers using frameworks like SASB and demand clear KPIs linked to ESG outcomes.
Risk management in private markets requires a different toolkit. Idiosyncratic, market, and macro risks must be assessed through scenario modelling and asset-level analysis. Sophisticated models like the one developed by Aberdeen (PRISM) help decompose risks and optimise allocations. For DC schemes, this supports better governance and member outcomes, ensuring that portfolios are not only resilient but also aligned with long-term objectives.
DC schemes can harness the full benefits of private markets – delivering growth, resilience, and sustainability. But success depends on thoughtful portfolio construction, active management, and a commitment to fairness across member cohorts. As the industry continues to innovate, schemes and their advisors must stay informed, ask the right questions, and partner with managers who understand the nuances of DC investing. The opportunity is clear – but so is the responsibility.
