Why should DC pension schemes be looking at private markets?
First and foremost because this is an asset class that should deliver better outcomes for pension savers. There are a lot of exciting growth areas within private markets, including private equity and venture capital opportunities in the life sciences and technology sectors. Some of these companies will become the industry leaders of tomorrow, so this asset class offers a real opportunity to deliver enhanced returns for savers.
But investment into private markets also offers important diversification benefits. It isn’t just about investing in these higher risk high return start-ups — private markets also include infrastructure, private debt and real estate assets, which have a very different risk profile and can help further diversify from listed equities and bonds.
Many private market investments focus on growing parts of the economy involved in the transition to cleaner greener fuels, for example, or in affordable homes. Our research shows people want to know where their pension funds are being invested, and they want to know these investments are delivering wider social and economic benefits so this can really help with customer engagement.
Is the cost of accessing private market assets prohibitive for low-cost pension schemes?
There is no doubt that the higher cost of accessing this asset class has acted as a barrier to investment in the past. But we don’t think this is an insurmountable hurdle. At Legal & General we think the key issue isn’t cost, but value, and all research indicates that a default that invests in private markets has the potential to deliver greater overall returns for members, even net of these higher fees, provided we have appropriate risk management safeguards in place.
Cost has been seen as a barrier by the industry, not the member. Research conducted by L&G last year among 4,000 pension savers found more than 70 per cent would pay higher fees for a pension that invested in infrastructure that supported renewable energy sources, and a similar proportion would pay higher fees for a pension that invested in affordable homes and better roads.
What specific challenges do DC schemes face when it comes to accessing private market investments?
These investments are not listed on stock markets, so by definition are less liquid investments. This has created problems for DC schemes which have traditionally offered daily pricing. But this isn’t an intractable problem. DC schemes have been investing in property funds for many years, which have similar issues around daily pricing and liquidity.
Regulatory changes, have helped, such as the creation of the Long-Term Asset Fund (LTAF)structure. But LTAFs are only part of the solution. Any private market solution for DC savers needs to capture the potential illiquidity premium. But in order to deliver this efficiently and to scale we need to move towards more automated operating models, where private assets are part of the default structure, and DC providers manage this liquidity through their cash inflows and outflows.
This is certainly the model that L&G is moving towards and mirrors to a degree how we manage investments into property funds at present.
What is driving demand for private market default funds? And do you expect to see this increasing in the years ahead?
As DC schemes have grown larger many are looking to diversify their assets to enhance member outcomes. Given the strong returns seen in private markets it is inevitable that schemes like L&G’s are looking at how best to incorporate this asset class.
At the same time there has been political and regulatory pressure, to ensure AE schemes are delivering for members but also to boost investment into the UK economy. This culminated with the Mansion House Compact last year.
L&G were one of the initial signatories, but it reflects work already underway to invest in private markets through our default. We have not signed up to this compact because the government has asked us to do so, it is because it is in the best interests of our members.
We will be launching our new multi-asset investment strategy soon, which will give millions of pension savers access to private markets, unlocking what has been a difficult to access asset class for the mass market.
We’ve had lots of conversations with employee benefits consultants and with clients, and it is clear that there is demand for a default fund that has a healthy allocation to these assets.