There is an urgent need for DC providers, private market asset managers, and general and limited partners from venture capital to increase their mutual understanding to make a success of working together.
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This was one of the key findings at a recent Corporate Adviser round table event, with panellists hailing from across the private asset and DC pension sectors. All felt that this divide needs to be bridged, particularly in terms of understanding issues around liquidity requirements and the asset allocation needs of DC pensions.
There was also debate over who, within this developing set of relationships, needs to take responsibility for which areas, as pension providers establish their own approaches and demands.
Yet DC providers remain broadly welcoming of moves to embrace private markets and expect higher returns as a result.
Jo Sharples, CIO for Aon’s DC solutions, summed this up. “After fees, we want to get better returns to members and better outcomes,” she said.
Ben Lewis, head of investment proposition for Mercer DC Solutions, said it is important to understand what this return is relative to. “If you want outperformance in equities, you need to be allocating to things that are at the punchier end of the private market spectrum. The initial focus is about getting access to private markets within these portfolios but getting to that next level of ‘are we getting access to the right asset classes?’ is going to be particularly important.”
James Monk, Fidelity’s investment director for workplace investing, said that up to now, defined contribution investing has been very cost sensitive.
“We’ve been going through an evolution of trying to understand exactly what value means. In the context of private assets, it’s absolutely key it is driven by returns and the quality of the solution, and less by the cost of implementation. Private markets are a very good area to get a bang for your buck.”
Understanding megatrends
Lushan Sun, head of cross-asset research, private markets, at L&G expects the additional premium pick-up, after an increase in fees, to be about 1 per cent and potentially higher in certain areas. Yet she believes providers also need to be aware of structural megatrends impacting specific areas, as this will affect potential returns.
“So, sector selection, thematic selection is almost as important, if not more important, than the asset class itself. As well as a strategic asset allocation, we look underneath to say what are the trends?”
Aegon’s head of investment strategy Niall Aitken, also stressed the importance of understanding the full cost of certain approaches. “Automatic allocation of cash flows, rebalancing generally and dynamic market allocations add cost and complexity to the whole default operation. Some people underestimate the complexity of reworking your system to incorporate bits that need to drift and bits that require more active cash flow management,” he said.
All parts of the glidepath
Martyn James, director of investment at Now: Pensions, stressed that while there was an understandable focus on returns, it was important not to forget the diversification benefits as well.
Evan Klironomos. investment proposition manager, Aviva agreed, adding: “We’re looking beyond that rigid approach to see how we can invest in private markets asset classes in a way that caters for that evolution of risks that members face along the entirety of the glide path. We’re exploring what we can do in each of the private markets asset classes to essentially reflect our views that certain asset classes — and certain sub-asset classes — might have different parts to play at a different phase of the glide path.” He said it was important to maintain flexibility and to be able to “allocate in a dynamic way and to cater for that evolution of risks”.
Aitken added that he is also “super-interested” in how resilience can be added to DC portfolios. “That’s all the way up to and through retirement. One broad asset allocation to private markets may be right for the growth stage, but you may then need to change. So how are you future proofing your structural designs and your allocations for different glide paths?”
Oliver Little, head of UK DC pension strategy at Neuberger Berman, added that there had been less published research into private markets and the decumulation stage.
Building flexible structures
Little suggested that providers might consider an “opportunistic” bucket to access assets that could provide outsized returns, but that might not fit neatly into some definitions.
So, for example, capital solutions sitting between private equity and private credit, or trade finance or GP-led secondaries. Sharples noted that defaults had already come a long way from what were very static approaches.
“We talk about a more tactical shift in the context of private assets, but we all recognise that it’s not necessarily that easy to shift some of them. But equally, we’ve got big schemes that have got lots of cash flow coming in. It does give you a bit of scope to flex,” she said.
This prompted Nalaka de Silva, head of private markets at Aberdeen, to note that the investors and the practitioner community have built a lot of systems for the “smooth transition of capital from DC to private capital” in other jurisdictions.
“This community has spent a lot of time building the necessary processes to allow for kind of the smooth transition of capital from the DC environment into private capital. That comes with a cost.
“But once that investment is made, as we saw in Australia, it becomes a normal thing. It does require quite a lot of thinking about how you do pricing and valuations, given the range of asset classes we’re talking about.” He saw that as another aspect of the challenge. “Private markets is a catch all term for everything that’s not listed. There needs to be standardisation. Parts need to converge. So, while there are special opportunities in investments, how do we give people a sense of: ‘Okay, if I’m investing in this, how do I compare it to something else that looks like it on the public side, so I can judge the difference’. These are the conversion points.”
Where does the buck stop with liquidity?
There was some discussion of where liquidity and other responsibilities rest. Monk said: “The vast majority of the structuring, the communication, reporting, and liquidity management should sit with the DC provider. That way the manager can focus on what they do best and not try to learn a whole load of new skills about dealing with DC members and liquidity requirements.” He also queried some GPs’ embrace of evergreen investment and potentially retail distribution.
Ben van den Tol, director, client solutions at CBRE argued there was a place for closed-ended solutions, alongside a more evergreen approach and made a distinction between private equity and infrastructure.
“Our view with open-ended evergreen [structures] is that it’s great for infrastructure. You are potentially holding that asset for 30 years all the way through to terminal value. You’re pumping in capital expenditure every couple of years. You’re refurbishing it. You’re evolving the asset and future proofing it over the longer term,” he said.
Lewis added: “That’s where Long Term Asset Funds (LTAFs) comes in. We’ve all gone through this somewhat painful process of designing and getting these LTAFs off the ground. Once you’ve got that in place, then you have lots of flexibility.”
Sun added: “Having asked for them, some open-ended structures are obviously helpful. But in other asset classes, especially more niche areas, say digital or venture, you’re not going to get open-ended funds. Therefore, you pay for managers based on their capabilities, and you manage liquidity holistically at the overall top level.”
De Silva felt a hybrid approach would be required, with some agreement on cash management all the way down the chain.
“That cash management is all the way through the chain, because if equity markets fall 20 per cent, okay, I’ve got a denominator effect, but I’ve got capital commitments, how do I fund them?
“That’s a communication line that needs to be opened up with the GPs directly. For example, don’t call capital, because I don’t want to reallocate from equities, because I’m going to take the bounce. But when the right time comes, we’ll allocate. But that doesn’t really work from the GP standpoint, because they’ve already committed to these projects. I think the communication channels need to be sorted. GPs are going to have to get closer to the DC providers in many ways.”
Improving governance
De Silva suggested that once you get the governance right on how the allocation and deployment mechanisms work, it brings confidence across the sector.
Sam Murphy, head of client solutions and product at Future Growth Capital said: “Within product markets, from an investment perspective, when you’re doing due diligence on a manager, we’ll ask for a line by line on every loan, every transaction. We then torture that data, do our own analysis, have lots of back and forth to make sure we’re really comfortable.
“That’s a lot of heavy lifting. There needs to be better communication from provider to asset manager to the underlying GP, in terms of language used, and the agreed terms. It needs a bit of work.”
Monk also raised the point about a provider perhaps wanting to communicate about an investment “when it’s a really nice message for the member. That is a very different dynamic for the GP universe to think about”.
A pitch in time
Aitken noted that one recent pitch contained a lot about the great investment opportunity, but didn’t make it easy for him to understand the return characteristics.That was, ultimately, his question to ask, but surely those working on the private markets side of things need to think about how to help him answer it, he said.
James also noted that a huge number of players want to pitch for business and yet the lack of understanding of the needs of the DC market remains huge. He said: “There are a handful that are really looking for the partnership and looking to understand your needs, coming to discuss how you structure the portfolio and the deployment of capital, understanding the sustainability needs, understanding the fees, and being DC friendly.”
Interestingly many panellists felt that a range of trade bodies from the British Private Equity and Venture Capital Association to the Investment Association have a role to play in helping foster improved mutual understanding.
Murphy remained optimistic that this was improving. “In our experience in the last 10 months, tier one, world class managers, with hundreds of billions of assets under management, get that this is a huge pool of capital coming.
“The world is moving to having better data, more transparency and more flexibility in structuring. And the best organisations will have an investment platform and structuring platform where they will be able to put different assets into different products for different investors and provide them with the reporting and support they need.”
As he concluded, some challenges still remain, but huge progress has already been made to date. Both DC providers and specialist private market asset managers “are on a journey”, he said but he remained confident of arriving at a destination that would help deliver better outcomes for members.
