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DC default funds are starting to increase allocations to private market investments. Aegon’s climate and responsible investment lead, Pauline Vaskou says this can be an effective way to boost member returns while helping address the myriad environmental and societal challenges we face today.
What benefits can private market investments offer to DC savers?
By investing in private markets, DC schemes can diversify their holdings more effectively, leading to improved risk-adjusted returns. More significant allocations to private market assets enable default funds to invest at an early stage in the companies that will shape our future economy, potentially delivering higher returns for members over the longer term.
In many cases, these will be the companies that are starting to address the various sustainability challenges we face as a society, particularly around climate change. So, investing in private markets can be an efficient way for DC schemes to meet longer-term sustainability objectives and net-zero goals, delivering benefits for members that go beyond the purely financial.
But it is important to stress that the starting point for DC schemes and investment managers is their fiduciary duty to deliver a financial return. Private market investment offers a way to do this while aligning with broader sustainability goals.
How can private market investments help with the engagement challenge?
With private market investments, members can see more clearly where their money is being invested and the potential impact this is having. For example, there may be an allocation to a private markets fund that is used to build a particular wind farm. This principle extends beyond investments that are directly addressing the issue of climate change. For example, there has been a lot of talk about ‘productive finance’ in the UK — be it the need to upgrade infrastructure, provide social housing, or build energy production facilities. With private market investments in these specific areas, members can see exactly where their money is being invested and how it is making something happen. This is very different from saying the default fund invests in a company like BP, which may also invest in renewable energy.
What are the particular challenges when it comes to incorporating private markets within DC portfolios?
Private markets are very different from listed equities and bonds, and present several challenges for those running DC schemes. These are far less liquid assets, and by their nature, designed to be held for the longer term. There isn’t the same opportunity to chop and change holdings as you go along, so as a DC manager we want to be sure we are selecting the right third-party managers and the right private market assets to deliver over these longer time horizons.
With listed equities, schemes are often investing in companies that already have a proven track record, but with private market investment, this is rarely the case — it is the future potential that is key.
This goes beyond just picking the right investment opportunities. It is also about selecting the investment managers that have the capabilities to take a more hands-on role with many of these companies, picking the right management team or selecting the board, and helping with the process of scaling up and building the companies of tomorrow.
How does stewardship in private markets differ from public markets?
With private markets, investment managers typically have a large holding in the company or project, which may be a majority stake. This gives them more influence and control, and this is key when it comes to delivering on sustainability and climate change goals. This can create a strong link between setting out policies related to sustainability and implementing the decisions needed to drive action on these issues. For DC members, this can be important as they can see the effects of this stewardship in action.
How is Aegon managing these risks and opportunities?
Aegon has developed its own framework, which sets out what we look for from private managers when it comes to responsible investment and managing ESG risks. Having a framework is important, as there often isn’t the same data available compared to listed bond and equity markets, particularly in relation to Scope 1, 2 and 3 emissions and other climate metrics. As asset owners, we are looking to ensure we can put in place effective monitoring and reporting of this data, alongside appropriate due diligence, to ensure material ESG risks are assessed and managed.
