Recent UK government policies suggest a push for defined contribution (DC) schemes to increase their allocation to private assets. Despite their performance, it seems some DC schemes are still apprehensive towards them. Why is this the case? For asset managers, the answer is not straightforward.

Nicholas Lyons, the Lord Mayor of the City London, has suggested a £50bn growth fund, to be financed with 5% of every DC schemes’ assets. DC schemes are growth orientated so this suggestion should be welcomed, as private assets offer long-term growth.

However, our DC Default Diversification Report, in partnership with Partners Group, shows that some DC schemes are reluctant to allocate assets to private markets. Among the top obstacles are the liquidity demands, which traditional private asset funds do not always meet. However, the UK government has actively tried to create conditions which support long-term investment by DC schemes, by introducing Long-Term Asset Funds (LTAFs). According to the Pension and Lifetime Savings Association (PLSA), one aim of LTAFs is to increase the confidence of DC schemes to invest in less liquid assets.

There are other obstacles for DC schemes investing in private assets. Among them are limited governance resources. The UK government has pushed for consolidation in the DC pensions market as a solution to governance concerns, so more DC schemes can scale and invest in private asset classes. According to the Pensions Regulator (TPR), the UK’s DC pension market has consolidated by nearly 40% in a decade. However, our Independent Trustee Report, published in partnership with Newton Investment Management, the Association of Professional Pension Trustees (APPT) and the Pensions Management Institute (PMI), uncovered that some DC trustees are concerned that this push for consolidation is unfairly penalising well-run small schemes and making the industry less competitive. 

Nevertheless, in order for DC schemes to effectively monitor private market investments, trustees would have to be trained in private assets and hire new consultants. For nearly three quarters of those schemes under £500m, the trustee board makes investment decisions, meaning few have an in-house investment team.

 

In contrast, larger DC schemes can establish stronger governance practices, with an in-house investment team, as well as train trustees on new asset classes. The Pension Regulator also finds smaller DC schemes normally display poorer governance standards, for instance placing less focus on training arrangements. These findings coincide with mallowstreet’s evidence and domain expertise. 

The biggest DC pension funds have far higher allocations to private assets than their smaller peers. According to our DC Default Diversification Report, 70% of DC schemes which have allocated 5% or more to private markets have seen returns that are in line with or above their expectations. This suggests that, despite the investment barriers, if DC schemes access private assets, they see them as a positive contributor towards their targets for net-of-fee returns. This is interesting because two-thirds of DC schemes and consultants say net-of-fee returns are very important in default funds. 

 

However, success is not just net-of-fee returns; risk also must be considered. One benefit of allocating to private assets is diversification: DC schemes can invest in different investment types such as private equity or debt. For example, Nest, a DC master trust with assets above £20bn, has announced that they are partnering with Schroders Capital to incorporate an allocation to private equity into their default funds. Private assets can perform well when listed assets are under pressure – so DC schemes recognise diversification as the top benefit of private allocations. 

In addition to DC schemes over £2bn finding success in larger private markets allocations, they also face fewer obstacles when investing in these assets. Only 12% of large DC schemes say their governance budget is a key obstacle to investing in private markets. In comparison, smaller schemes are more likely to struggle with their governance budget. So, it seems DC schemes with smaller allocations have a harder time achieving success. 

 

Our research for Partners Group in 2020 revealed smaller schemes up to £500m have not yet invested in private markets. For example, despite the UK government’s efforts, only 22% of smaller DC schemes say they are interested in private equity. This reflects that while smaller schemes appreciate the diversification benefits these assets provide, they have more limited diversification options than larger schemes. In fact, just 9% of smaller schemes have future plans to allocate to private assets.

Managers are facing a difficult environment in understanding what smaller DC schemes truly want and can afford. The investment incentives introduced by the UK government to encourage DC schemes to invest in private assets are not helping all schemes equally. With further research, we can investigate the different attitudes of trustees, so that managers can design and present the most relevant solutions. Contact us if you would like to become a research partner, strengthen your brand, and improve your positioning across the UK institutional market.