Private markets are being rapidly incorporated into DC strategies, with this shift being accelerated by the Mansion House Accord. This will see most multi-employer workplace pension providers allocate at least 10 per cent of their default funds into these assets by 2030 — half of which will be invested in the UK.
Prior to this, a number of master trusts, including Nest, NatWest Cushon and Smart, had started to diversify portfolios into private market assets. But this trend has stepped up a gear, with leading DC workplace providers — including Aviva, Fidelity, Legal & General, People’s Pension and Standard Life — announcing new default investment strategies that will see significant funds allocated to these asset classes in the coming year. Across the industry there is broad agreement that this will help schemes manage risks more effectively and deliver better long-term returns for members.
However, there is less consensus on the most effective way to access and manage these assets. Some schemes are incorporating private assets into a principal single default, with others opting for a multi-default strategy, giving employers choice on charges and investment mix.
There are also differences in how schemes manage these assets, be it direct ownership, partnerships with one or more specialist asset managers, or access through a range of vehicles such as LTAFs (Long Term Asset Funds).
These various approaches highlight the importance of effective communication with both employers and members. This also needs to embrace the complexities inherent in private markets, including liquidity, volatility, valuations and ESG factors — all of which feed into the core issue of cost versus value.
Advisers across the industry say getting this communication right from the outset is key. There are challenges when it comes to communicating potential risks, such as price bubbles in the UK market, pricing volatility or gating.
But done right, clear communication about the benefits of private market investments could create better engagement with members on pensions.
“It is important to communicate the value of these types of investments to members, given their higher cost and complexity, and to make sure risks are noted, as with any type of investment,” says LCP partner Stephen Budge.
“There are concerns about risks such as liquidity and the Government pressure to invest in the UK. But these can be handled appropriately and have not created barriers for schemes investing in these types of assets.” But this, he says, needs to be communicated to employers, who may be more hesitant.
Zedra client director Sam Burden agrees, and says corporate advisers and consultants have an important role to play, when it comes to communicating both benefits and risks to clients. “All these questions hinge on communication and setting out a clear business case for the investment strategy, and how this will
be delivered.”
Burden says schemes need to communicate more than just the underlying premise, that private markets can increase diversification and help boost overall returns. There is a need for specifics on how they plan to deliver this, he says. “The pension provider needs to set out what it is trying to achieve, how it will do that, and why it will cost more than the very cheapest strategies.”
Aviva director of investments, Maiyuresh Rajah says: “We have done a lot of work on incorporating new disclosures and how we are going to communicate private markets.” He says engagement with clients is key to ensuring they understand the decisions that providers like Aviva are making when it comes to incorporating these less liquid assets into wider portfolios.
To date, Budge says there has been “notable interest from employers and trustees” and encouraging signs of take-up. But going forward he says there needs to be transparent communications around costs and returns, so advisers, employers and trustees can evaluate whether these strategies are delivering value for money.
Burden says this underlines the importance of ongoing governance oversight, reviewing investment performance to assess how the default and underlying allocation to private markets are performing on a net-of-fees basis.
Barnett Waddingham chief investment officer Matt Tickle points out that the DC pensions sector remains a price-sensitive market, “with cost consistently cited as a key factor by both employers and trustees when selecting or reviewing schemes”.
But while industry sentiment is shifting towards a value-based assessment, this transition will take time he says. “Given this, multi-default strategies may serve as a useful transition mechanism while track records develop, although this does create a risk: if private markets underperform in the near term it could undermine confidence in their long-term value proposition.”
He adds: “We are also seeing commercial pressures leading to some solutions coming to market that may be sub-optimal. Rigorous due diligence remains essential to separate genuine value creation from cost-cutting that compromises quality.”
To do this, advisers need transparent information and clear communication about schemes’ investment strategies.
Engagement opportunity
Providers and advisers are optimistic that the inclusion of private markets could encourage greater member engagement with workplace pensions, ultimately helping to improve outcomes at retirement.
Quantum Advisory principal investment consultant Paul Francis says: “Getting engagement from members has always been a challenge.”
But he says people tend to be more positive, and more interested in tangible investments, such as housing or infrastructure. “If people think their pensions are helping fund these assets then many would see that as a positive.”
Burden says this should particularly apply to UK-based investments. “For most members talking about private markets as an asset class is just more pensions jargon. Reframing this as ‘your pension assets will be invested in the UK to develop infrastructure, increase housing stock or boost the nation’s social capital’ is likely to be viewed far more positively.”
Budge adds: “The power of real-world assets, combined with photos and storytelling, offers a significant opportunity to improve engagement with members.”
This is something that providers are already exploring: NatWest Cushon, for example, highlights its investment into low-carbon farming, including the UK’s biggest glasshouse in Suffolk, which currently produces over 100,000 peppers a week.
However, Tickle points out that while tangible assets like infrastructure and housing can create initial interest, he is “cautious about overstating the engagement impact”.
He points out that other private market assets, such as private debt, venture capital or private equity can be hugely complex and are unlikely to grip the average member.
Tickle says it is important to look at what this engagement is trying to achieve. “There’s an important distinction between members feeling momentarily positive about their pension investing in recognisable assets versus taking meaningful action like increasing contributions or reviewing their retirement plans.
“We’d prefer to see member engagement focused on the actions that truly matter, such as contribution levels and retirement planning decisions. Investment strategy is best left to providers and professional advisers.”
He added: “There have been similar engagement narratives around sustainability investments which haven’t delivered the anticipated uplift in member engagement.
“The investment rationale for private markets should stand on its own merits, improved diversification and return potential, rather than being positioned primarily as an engagement tool.”
ESG challenges
Many see private market investments making a valuable contribution to schemes’ ESG and net zero objectives. But advisers again stress the need for effective communication around this. “Timing considerations will be important,” Tickle says. “For example, building renewable energy infrastructure may result in higher emissions today but significantly improves the likelihood of achieving long-term net zero goals. When members review ESG reports and see metrics like Scope 1 and 2 emissions, schemes need to communicate this ‘systems-wide’ perspective clearly.
“Private markets offer the advantage of more direct, targeted impact, but this requires moving beyond simple carbon accounting to demonstrate real-world contributions.”
Carbon metrics are harder to compile for many private market investments, with data collection lagging behind that now required of many publicly-listed companies.
Francis also points to the increased polarisation around the net zero debate, which may lead to challenges in terms of engagement. While some members may be keen to see their pension invested in UK green infrastructure and offshore wind, for example, others may actively disengage with what they perceive as ‘woke’ investments. Communications will need to carefully set out the investment case to address this.
He adds: “There’s also a large regulatory risk here, in that opposition parties are stating their intentions to row back on climate commitments, and this could well come into effect after the next general election.
“Assets that may now look attractive because of the regulatory structure or financial support initiatives could be less compelling in only a matter of years.”
Liquidity and gating
This might not be the only challenging aspect of private market investing that will require thoughtful communication. Francis highlights the limited supply of compelling investment opportunities in the UK, and its potential impact on pricing.
Gating is another area of concern, but most did not think this would be a pressing issue for members. Burden says: “There are challenges around gating, but providers can overcome these with well-structured products. Most members won’t be realising assets until age 55 or later, so this can be accommodated.”
Budge adds that most DC schemes and master trusts are “awash with liquidity”, given they typically have strong positive cashflows. “Taking on some liquidity risk is unlikely to affect members on a day-to-day basis,” he says.
“The important distinction to note is that private market investments sit better in a default strategy where illiquidity risks are managed through the overall strategy design. It is much harder to manage these risks through self-select choices, and hence we have not seen these investment choices made available directly to members.”
Tickle says: “The key principle is appropriate communication to the right audience. For members, private market investments should typically be held within default funds where trustees and providers have conducted extensive due diligence on the assets, managers, co-investors, and cashflow requirements.
“Members should be informed about outcomes and benefits rather than operational complexities like gating arrangements.”
He says the industry needs to be careful not to “over-explain technical risks” and inadvertently create concerns about issues that are highly unlikely or already well-controlled by governance structures.
Private markets offer the opportunity for new narratives about workplace pensions. But while these assets offer clear potential, this needs to be backed up with clear evidence that this is delivering better long-term returns for savers.
The inclusion of private markets has certainly delivered in both the DB sector and in overseas DC markets. If replicated in the UK workplace market, this should drive better engagement with members and improve retirement outcomes.
