Defined contribution (DC) schemes have over the years looked for ways to increase participation, enhance investment choices and help participants reach better retirement outcomes. However, one area that has at times proved a struggle is introducing investments that can meaningfully enhance diversification beyond traditional equities, fixed income and cash. Private equity, which has historically provided an attractive risk/reward relationship in the context of defined benefit plans, has been an enticing but elusive category when it comes to the DC world, where inclusion has been limited by structural impediments such as illiquidity, limited transparency, regulation and fees.
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With structural improvements on all these fronts, combined with the ambition to introduce private market asset classes into DC schemes, highlighted by the signing of the Mansion House Compact in 2024, we believe that it is now appropriate for schemes to consider the addition of private equity, alongside other private market assets. There are still hurdles, and investors should be aware of the range of investment outcomes that are possible in private markets. It is therefore important to understand the impact of selecting between different managers and approaches to private equity investing.
While investing in primary funds can help to build a well-diversified portfolio over time, they typically incur significant fees at the LP level and can take considerable time to fully invest the committed capital. Investing via secondaries can speed up capital deployment, but the fees are similarly high. In both cases, the LP has little control over what goes into the portfolios.
In comparison, we believe co-investments, which are direct investments into private companies made alongside a private equity manager rather than through a fund, offer significant benefits for DC schemes. Co-investing enables managers to be more actively involved in the investment selection and due diligence processes. And co-investment capital is typically offered with lower management and performance fees than a traditional fund, and sometimes with no fee. Though co-investing is more resource-intensive compared to a primary or secondary approach, having control over investment selection enables managers to better align portfolios with scheme objectives, by targeting specific sectors or regions, for example, or balancing growth equity and buyouts.
Picking a co-investment partner that can provide consistent and high-quality deal flow is an important requirement for a successful co-investment strategy. We believe that being able to draw on an established private markets platform with strong relationships across numerous private equity managers is vital. We also believe that partners need to understand the specific challenges of UK DC schemes and have the skills to structure the appropriate solutions to meet those challenges.