8 minute read
Regulation
UK TO UNLOCK DEFINED CONTRIBUTION PENSIONS
As defined benefit (DB) pensions phase out, concerns over liquidity and fees among DC pensions are being investigated by advisers and governments in the UK
Defined contribution (DC) pensions are set to become dominant investors in private market funds within the next two decades.
UK investment consultants are leading the way in researching ways to access this largely untapped market, promising benefits for private equity fund managers globally.
According to The Pensions Regulator, workplace DC assets in the UK were just over GBP500bn in 2021 and are expected to grow in value to GBP1 trillion by 2030. Some DC-based pension funds such as Nest (which recently committed GBP1.5bn to private equity) are targeting private equity in anticipation of greater opportunities and innovation.
Fund managers including Schroders, Blackrock, and Partners Group have been linked to the investor segment in recent reports.
“Every investment consultancy specialising in DC will be researching this given its potential to improve retirement outcomes for members of DC schemes,” says Hugo Gravell, investment actuary, Barnett Waddingham.
Moving hurdles
DC schemes differ from other pension schemes as, unlike defined benefit schemes, they depend on how much an individual investor contributes to the pension, as well as on how well the investments perform. Due to the risks that are involved with DC schemes, pension holders have greater valuation and liquidity demands – characteristics traditional private equity funds are not usually known for. Conditions have been created by government intervention to support the requirement for more long-term investment in DC pension funds, but high fees and illiquidity issues still represent hurdles.
“Defined benefit is going to get supplanted by defined contribution plans,” says Andrew Brown, head of private equity research at Willis Towers Watson. “However, DC plans have charge caps and require daily liquidity and valuations, which doesn’t work well with the current private equity closed-fund model.”
In June 2021, the UK government published ‘The future of the defined contribution pension market: the case for greater consolidation’. It noted the “exponential growth” of defined contribution plans since 2012, when automatic enrollment was first introduced. As of 2021, there were 1,560 workplace DC schemes in the UK, with more than 12 members – a reduction from 4,560 in 2010, offering schemes greater scale to achieve better How Europe’s DC pensions allocate to alternatives
Netherlands
UK
Spain
France
Denmark
0 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Private equity Growth fixed income Real assets Hedge funds and DGFs (Diversified Growth Funds) Other
Source: Mercer, 2021
investment outcomes through consolidation.
As the pension industry shifts away from defined benefit (DB) plans in the UK, an opportunity has presented itself to investment managers to improve access to DC assets.
“Private equity should not just be for the DB pension era but to make it commonplace within DC schemes, more work and, in some cases, a reset of expectations is needed,” says Richard Dowell, partner and co-head of clients, Cardano.
The UK government has also put a 0.75 per cent charge cap in place to protect pension holders in DC schemes from high fees when investing in private equity. In November, the Financial Conduct Authority (FCA) helped launch the Long-Term Asset Fund (LTAF) to remove barriers and boost investments in private equity.
Yet some large pension schemes have been openly critical of these initiatives, arguing that it is not the government’s place to play a role in asset allocation.
Others are growing their allocations anyway. Nest wants to allocate 5 per cent of its AUM (cGBP1.5bn) to private equity by 2024 and is reported to be selecting fund managers. Stephen O’Neill, head of private markets, Nest, said in August last year that the fund expects to invest GBP80bn over the next 20 years, with the aim of “private equity playing an important role in our portfolio, offering strong returns and diversification”. When asked for additional information, Nest told Private Equity Wire that it was in the middle of active procurement and so unable to comment.
DC dominance
According to Mercer’s European Asset Allocation Insights 2021, alternative allocations in UK DC plans remain heavily dominated by hedge funds. Out of 6 countries, including the UK, the Netherlands has the largest allocation to private equity (this was skewed by a large allocation by a single investor), followed by Denmark and France (see previous page).
DC will be the dominant asset owner in private equity within the next 10-20 years, according to global investment advisor Willis Towers Watson. It is one reason the firm is so keen to come up with a solution to the issues around valuation transparency, fees and managing liquidity in an illiquid asset class.
“We have a task-force who talk to large asset managers, both on the public and private side, and who are looking to create a solution or product that will allow asset managers to access this new and fast-growing market,” says Brown.
Possible solutions include mitigating drawdowns, such as through ‘blended funds’ where a pension has investments across different managers and across different asset classes, including private equity, offering access and control over some of the liquidity. Partners Group was reported to be the first private markets firm to launch these types of ‘semi-liquid’ funds in the UK.
As DB schemes are phased out, it is important for the same investment opportunities to be available to those who only have investments in DC schemes, say advisers in the space.
Last October, the Pensions and Lifetime Savings Association (PLSA) (UK pensions) launched a Made Simple Guide on long term asset funds (LTAFs) which aims to explain the benefits of diversifying your portfolio by investing in private markets. The guide encourages a focus on long-term net returns, rather than initial fees.
Advisers spoken to for this article, including at Barnett Waddingham and Redington, point to the industry wide efforts to help DC schemes The UK’s largest DC pension providers
Legal & General Aviva Scottish Widows Aegon Standard Life
Total DC Assets - GBP
114bn 81.3bn 68.2bn 57.9bn 43.1bn
Source: Master Trust and GPP Defaults Report, April 2021, Corporate Adviser
NUDGING GLOBAL PENSIONS
In the US, the average target allocation of pension plans to private capital was 30.7 per cent last year, according to Public Plans Data, increasing from 28.7 per cent in 2015. The incremental percentage change represents an added USD143 billion in investment. Pension funds in other developed economies are moving in a similar direction. In Switzerland, since January 1 this year, unlisted assets are considered a standalone investment category for the country’s pensions with an allocation ceiling of 5 per cent of total assets (instead of falling with the alternatives investment cap of 15 per cent). According to Mercer’s 2021 Asset Allocation report, the average allocation for European defined benefit pension plans was 53 per cent to fixed income, 21 per cent to equities, 23 per cent to property and alternatives, and 3 per cent to cash. The ongoing move of these schemes to de-risk out of equities has kept allocation trends fairly steady, but alternatives have benefited, it says. In a survey by the company, most European investors reported plans to increase exposure to alternative assets while decreasing exposure to equities. A similar survey in Japan found that approximately 60 per cent of corporate defined benefit pensions have already invested in private assets, and approximately 50 per cent intend to increase private markets allocations over the next five years. Asia has long been identified by many of the large-cap private equity funds as a fertile hunting ground for under-allocated pensions (see page 19) but despite being a home to ‘whales’ such as Japan’s GPIF and South Korea’s National Pension Service, private equity fund commitments have been slower to ramp up. NPS has been steadily diversifying its USD778 billion AUM beyond fixedincome investments, with alternative investments, including private equity funds, increasing 28 per cent between 2007 and 2017, according to McKinsey, however it has often fallen short of its target allocation. Japan’s GPIF – the world’s largest pension fund – has also tended to be under-allocated to private equity but last year showed signs of a more aggressive push. In a paper posted on its website, it said a portfolio of exchange-traded assets capable of tracking the longterm performance of private equity benchmark indexes would open the door for institutional investors to “rapidly scale up exposure without worrying about illiquidity.” In the summer of 2021 it earmarked more than USD6 billion for private equity.
invest in private markets. Barnett Waddingham sits on the Productive Finance Working Group which is cochaired by the Bank of England, HM Treasury, and the FCA.
Redington also claims the UK government aims to have private equity investments available within the next six months.
“The DC industry has been discussing allocating to private markets for several years, but there’s certainly been a more concerted push from the government, regulators, and the pension schemes themselves all pushing in the same direction. I would expect to start seeing some fund launches under the LTAF banner again by the middle of this year,” says Jonathan Parker, head of DC, Redington.
The UK Treasury did not provide a update to Private Equity Wire on the plan despite multiple requests.
Other private equity markets globally will be taking note but may be slower to reform.
Investment advisors in the US agree that DC is “extremely topical” as an allocation trend, but many don’t feel that it’s within their grasp for private equity just yet.
“It’s an extremely challenging process, and many of the regulatory hurdles that are passed are then met with other hurdles,” says Chris Shelby, director, private markets, US-based Verus Investments. “Progress has been made, but slowly,” he concludes.
US-based adviser Colin Murfit, director of research at Alan Biller and Associates, adds: “DC is a huge multi-trillion-dollar market that private equity hasn’t addressed at all. So the question is, will private equity ever be able to find a way to get into DC portfolios?”
