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Why are private markets becoming increasingly relevant for the DC sector?
Private markets have become a key part of most DC investment strategies. This has been driven by policy momentum and recognition this asset class can help deliver better outcomes for members.
Both Conservative and Labour Governments have encouraged this, via the Mansion House Compact and Accord. This has seen major DC providers pledge to increase both UK and overseas private market allocations.
There is a strong economic rationale for doing this. Many areas critical to UK growth — such as infrastructure, energy transition, regeneration, housing, and science and technology — require private capital alongside public funding. Pension schemes, which invest over long time frames, are well placed to provide this capital, with a view to generating stable, long-term returns.
By looking beyond listed equities and bonds DC schemes can access growth opportunities not available in public markets.
ACCESS THE DCALTA/CORPORATE ADVISER PRIVATE MARKETS WEBINAR ROUND-UP PDF HERE
What benefits do private markets offer?
The key benefit is this potential for outperformance. But this requires a DC scheme to take a more active, research-led investment approach, particularly when compared to the lower-cost passive strategies that are often deployed when investing in publicly-listed equites and bonds.
Private markets offer a very different risk and return profile. For DC schemes to successfully invest in this area requires thorough due diligence and careful asset selection, alongside and a clear understanding of issues around liquidity and duration.
Private market investments typically aim to generate returns over the longer term, so there is a natural alignment to DC saving horizons and their broader investment objectives. This can also help schemes move away from the “herd mentality” that can be created when focusing on shorter-term market movements. It is also worth noting that while private markets are a relatively new addition to DC, they are not a new asset class at all. These investments are a well-established component of DB schemes in the UK, and part of DC schemes in the US, Australia and Canada.
What challenges do DC schemes face when it comes to building allocations to private markets?
Institutional investors have been investing in private markets for decades. The challenge for the DC market has been adapting structures to allow unitisation and daily pricing. There has been significant progress on this though, with the launch of new fund structures such as Long-Term Asset Funds (LTAFs). This has helped address challenges around liquidity, although the current net positive inflows of contributions into DC schemes also helps mitigate these risks.
Finding quality investments, particularly in the UK may be a challenge, given the sums the DC sector is looking to invest over the next few decades.
There is also the question of transparency around costs. Private markets have higher charges and may levy performance fees. These need to be clearly set out and explained to trustees, advisers and members. Measuring the performance of private market assets has historically been more difficult, particularly given their limited track records in DC. The development of forward-looking value-for-money metrics, alongside tools such as CAPAdata, should help schemes assess both past and expected performance more effectively.
Finally, it’s important to remember not all private market solutions are the same. Some fund structures will hold higher levels of cash, for example, which can dilute genuine private market exposure. Education and governance underpin all of this. Trustees and advisers need to understand how private markets work, and the potential positive impact on longer term outcomes.
What is Standard Life’s approach to private markets?
Standard Life has partnered with Schroders Capital to create Future Growth Capital (FGC). This combines our experience in DC markets with Schroders’ expertise in selecting and managing private market assets.
FGC offers two LTAFs: one focused on UK private market opportunities and one global fund. These are open architecture LTAFs, allowing access to other asset managers where appropriate.
In terms of allocations, Standard Life expects private markets initially to make up around 5–10 per cent of default fund assets. Higher allocations — potentially up to around 25 per cent — may be appropriate over time for more adventurous investors, but only where sufficient high-quality opportunities exist.
Choice is a key part of this. Standard Life will offer a range of strategies, to reflect different client needs. However we want to ensure in time that defaults include some private market exposure.
While private markets may involve higher fees, the aim is to deliver better long-term retirement outcomes. As the DC market matures we see it shifting towards a more value-orientated approach, with schemes judged on performance and outcomes, not just price.
