Many DC workplace pensions schemes are set to embrace private assets urged on by the Government and the prospect of higher returns, but what, roughly, is an appropriate percentage for schemes to adopt?
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This was one of the key questions debated at a recent round table, hosted by Corporate Adviser.
Consultants and advisers at the event suggested that allocations as high as a quarter of the fund appear to be the target for most providers and master trusts – although a couple of advisers discussed the theoretical possibility of a 100 per cent allocation.
But most agreed exact allocations will depend on both the scheme and employer.
Jonathan Parker, head of defined contribution & financial wellbeing, investment consulting, Gallagher said: “Somewhere between 15 per cent and 25 per cent seems to be the medium-term strategic weight that a lot of the larger master trusts and the DC providers are aiming for.”
Glidepath matters
Parker also pointed to the need to consider where members are on the glidepath. “Maybe more thought needs to be given to the latter end of the glide path, where the liquidity requirements are a little more acute, and some parts of the private markets universe may not be as appropriate,” he added.
Jit Parekh, a partner in Aon’s DC team, says: “It very much depends on the client, where they are, their investment knowledge and training.
“If they’re looking to move to a master trust as part of their long-term strategic plan, it may make sense to have a zero allocation because of the illiquidity lock off that might come from private markets, so the answer to the question is anywhere between zero and up to 25 per cent.”
Isio senior DC investment consultant Jacob Bowman pointed out schemes need to ensure the implementation is right, otherwise they might be better off sticking with public markets.
“Don’t appoint a manager or a fund or a private market solution that is going to be run poorly with bad GPs, bad implementation and governance, because that will be worse than sticking with non-private markets. That’s almost an asterisk against doing private markets. If you can’t do it well, don’t try.”
However, he suggested that up to 25 per cent could for the largest schemes be appropriate if using “best-in-class implementation, good managers, broad diversification and a global approach”.
Mark Searle, head of DC investment at XPS Pensions, added: “It depends on what you measure, because we all agree the prospective returns are higher which might mean a much higher allocation to private markets.
“But it’s the constraints. It’s your cash flow requirements, that type of thing that starts pulling that allocation back down. Yet I’d agree with everyone here. I think 15 to 25 per cent, is a very sensible allocation.”
Market consolidation
Roger Breeden, trustee executive at BESTrustees, said one issue will be the relative maturity of the market. “As the market consolidates down to fewer providers, there’s massive cash flow going into schemes. So, from where we are now, these sorts of numbers seem appropriate, but if the market gets to a smaller number of schemes, with lots of cash flow, there is potential for it to go higher.”
Rob Skelton, head of retirement research at First Actuarial, said: “The optimal theoretical is probably 100 per cent, because they offer higher returns. You’ve got a long timeframe, more risk but over that time with returns, risk will disappear or diversify away. But it’s back to the constraints. How much illiquidity can we cope with? How confident can you be on those predictions? People might take the money elsewhere and then you’re stuffed as you have no way of getting the assets out.”
Nigel Dunn, partner in the defined contribution team at LCP, also pointed to higher allocations in Australian superfunds. “There’s a lot of appetite for private markets, and that’s why people look at initial allocations of 15 to 25 per cent. But you can look to Australia. The Hostplus superfund has an allocation of 40 per cent. They say that’s because their membership is relatively young, with relatively low salaries, so they are looking to maximise returns as much as possible, and that makes them quite different from the rest of the market.”
He added: “We’ve got the same considerations here. Maybe we don’t have industry funds, but we still have different memberships in different schemes. You could make the case as the market matures to look at 40 per cent allocations to private markets. If you already look at schemes like USS, for example, they’re already at that number, albeit from a DB perspective.
“We’re definitely at the stage of ‘We want to invest. We want to make it meaningful, but let’s not get burned in the process. Let’s make sure we allocate a reasonable number and watch how performance comes through’.”
Searle added: “You’re giving up liquidity and want to be repaid for that. So, we’re looking for something that’s going to be returning in the teens. You can accept that there are some risks. You’re going to get a few zeros in that mix as well. So, you need to be at least outperforming equities. That’s your target really with investing in private markets.”
Gradualism, not force
From a provider’s point of view, Mike Robinson, business development director at Standard Life UK, said: “We’ve set out where we sit on this with a fairly high conviction approach and a solution that we’re launching early next year.
“But equally, there are market participants and members that aren’t ready to have that forced upon them, so we’ve got to take the market on that journey. So there’s a part of the market that will want a gradual transition to this brave new world.”
Finding value while meeting Mansion House
Future Growth Capital’s chief investment officer Ped Phrompechrut set out how FCG finds relative value trade in three strands. He said: “The first is what are the core building blocks to allow you to be truly strategic and cross-cycle, rather than try to time and tactical trade.
“The second is what’s attractive at the moment, based on actual sourcing, what is coming through. I might mention the kind of late cycle indicators that we’re seeing. So what does that throw out now?
“Liquidity is a bit slower. You see things from continuation vehicles all the way through to a kind of hybrid capital structure. So, these are the areas where you toggle towards, that you create new allocation for, or you move down some of the core exposure to create room for that relative trade.
“The third is the toughest, because it’s very highly contextualised to individual portfolios. We’re basically GBP nominal portfolio or USD nominal portfolio. So, then the relative trade is not cash plans; it’s not inflation linked. It’s ‘if we need to hit that number and there are assets that on a risk-adjusted basis start to look better, then we can trade for it’. More specifically, there are just a lot of very good assets coming to the market every year, in certain areas like private credit.”
Parker added: “It will depend on age cohorts of investors to a certain extent. But with the DC master trusts, there are lots of ways they can manage liquidity. Look at Aviva: £100bn of assets, money in and out all the time.
“If you look at the platform levels of the bigger master trusts and DC providers, there are different ways of managing the liquidity.
“It is important you stress test portfolios for different scenarios and market events, or large pools of money coming out, but it is quite rare, if you are big DC provider with tens of billions of pounds of assets, that a single client taking money out is going to swing things that much.”
Mandation concerns
Panellists still have misgivings about mandation, especially around allocations to the UK.
Parekh said: “This is the issue with mandation is the extent to which you are basically saying you have to have a certain amount in the UK. The opportunity cost of investing that is losing a global opportunity, that’s where a lot of clients will look and say, ‘well, hold on a minute’.
“If the UK is the right place to invest for all the right reasons, that absolutely makes complete sense. But as soon as you put a mandation on it, you need to ignore some of these other aspects to hit this magic number. That is where people start to get uncomfortable.”
Searle also had doubts about mandation. He said: “What’s the ultimate game? With DC pensions is it to get members their pension pot, or is it to boost the economy, or is it to improve UK infrastructure and quality of life?
“If you ask members — do you want to have better local schools, but you’re going to have a smaller pension pot because of it, or do you want to have a bigger pension pot — it starts to bring in political risks and personal views, like we saw with ESG over the last few years.”
Barnett Waddingham principal and senior investment consultant Gareth Doyle added: “You’re hoping to be in a better environment when somebody retires. In reality, if it turns out not to be, the member says, well, you could have got me better returns if you hadn’t focused on that.”
It was noted that there was a potential for forced demand reducing returns in the venture capital sector. Too much mandated money flowing into VC and related assets could dent returns in this asset class.
Skelton said: “There could be a risk to the asset class created by a drive to meet political objectives. It’s a difficult balance to strike between the politics and the member outcomes.”
Breeden added that you could end up in a complicated debate about what is and what isn’t UK.
Opportunities knock
But Phrompechrut said that there were lots of opportunities. “Talking of mandation, it is trying to solve a problem. The problem is that a lot of UK innovation growth is being starved of capital from the UK, so, it is taking capital from international investors – North Americans, Australians, Europeans, the Middle East, Asia.
“I think the question mark should be how do you solve this problem without forcing the issue — in other words, it is still incumbent upon providers to pick the right managers to execute well, and ideally they have to be aligned to a good outcome. And if they’re doing that, if that whole chain is working properly, you wouldn’t see a bad outcome.”
He added that across private equity, venture, real assets and debt, there are really attractive pockets of opportunities.
“Within our deal pipeline just within two of our six strategies, this year alone, we saw the top of the funnel being more than five times the aggregate vehicle size. We can be really selective, so there’s certainly no forcing the issue.”
Murphy agreed that the private markets universe is expanding, due to very few IPOs in the equity market, and an expansion of private credit, due to banks restricting some of their lending.
He says this is good news for the DC market, looking to divert allocations into private markets.
“You’ve got a situation where the money coming in is not as big as people think and you’ve got an expanding opportunity set, we just don’t think the supply and demand is as out of whack as a lot of people say,” said Murphy.
While there were concerns about mandation, and the focus on UK markets, the consultants at the event were optimistic that significant allocations to private markets across the global economy, carefully implemented, would help drive better returns for members, without exposing them to undue risks.