Three steps to unlock the potential of private assets for DC schemes
An evolving regulatory landscape and ongoing product innovation has brought focus on the potential benefits of including private assets in defined contribution investment strategies, but what are the key considerations for investors?
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The landscape of the UK's DC market is changing.
On one hand, policymakers are keen to promote the case for retirement capital to be deployed to invest across the UK economy, including via private assets. On the other, private assets may be the answer DC schemes have been seeking to tackle diminishing high-return potential in public markets, while satisfying growing expectations for robust, positive member outcomes.
Private assets, including private equity, private debt, infrastructure and real estate, present a compelling investment proposition. Noted for their potential for high returns, expansive asset selection across various industries and viable opportunities for impact investing, their allure is substantial.
Perhaps most importantly, these assets are broadly uncorrelated to public market investments (see chart), meaning they could bring valuable diversification to portfolios.
However, just as with any investment undertaking, private assets come with their own set of challenges to navigate. These include reduced liquidity, higher fees and expenses, and intricate due diligence procedures. In addition, the limited transparency often observed with private assets can make informed decision-making trickier.
Overcoming these barriers forms the foundational layer of making a successful move into investing in private assets. Moreover, new product types, such as the UK’s Long-Term Asset Fund (LTAF), may make some of these challenges less daunting.
Redefining DC strategy: Incorporating private assets
For DC investors assessing the potential of incorporating private asset investments, via LTAFs, to enhance outcomes for members, it is crucial to take a considered approach. This should cover the specific objectives of the scheme, trustee and member preferences, and the nuanced impact of private market allocations on potential returns, liquidity and risk profile, and broader factors such as sustainability integration.
Step 1: Assessing the suitability of private assets for the scheme
At the core, the key question for scheme managers to address is: would an allocation to private assets yield better outcomes for the scheme's members? The following factors can significantly influence this decision:
Scheme-specific factors: For instance, a scheme planning an imminent transition to a Master Trust or a closed scheme might prioritise liquidity and capital preservation, respectively.
Size and status: Larger schemes or those open to new members with considerable ongoing contributions could potentially reap more benefits from private assets and are more likely to manage the associated challenges.
Trustee investment beliefs: It's crucial to incorporate trustees' views on numerous factors, including fee burden, the complexity and transparency of strategy design, and perceptions on sustainability and its integration into the investment process.
Employer-specific factors: Anticipated changes, such as potential layoffs or similar decisions, could bring considerable impacts and should be part of the decision-making process.
Step 2: Determining the ideal allocation and position within the glidepath
If a scheme is potentially suitable for investment in private assets, the next step is determining how much to invest and where to position such investments within the retirement glidepath.
Using the demonstrative case of a 15% allocation to private assets in the growth phase of a default investment strategy, some of the key considerations and modelling techniques that can aid the decision-making process are set out below.
Return objective and risk tolerance
Anticipated returns from private assets should be in harmony with the scheme's overall return objectives. While private assets may enhance opportunities for positive diversification, they may simultaneously introduce additional risk factors to be navigated.
In this example case, funding the private assets allocation from the scheme’s existing equity holding allows us to ramp up the expected return while reducing the expected volatility, consistent with the scheme's risk and return objectives.
Consideration of expected member outcomes may also be useful. Using our illustrative example above, the chart below displays the expected outcomes at retirement, highlighting that the median outcome increases the size of the retirement pot by £16,000, or £1,000 per annum of retirement income.
Remember, this is a basic illustration, and we encourage engagement with your advisors to discern the expected impact on member outcomes.
Time horizon
An important initial consideration here is, how important is liquidity approaching, at- and post-retirement? In our representation, we're allocating 15% to private assets during the growth phase and divesting fully 10 years prior to retirement.
But private assets shouldn’t necessarily be confined to the accumulation phase. Liquidity is often in-demand at retirement, but the question arises: do retirees always need 100% of their portfolio in liquid assets? Over time, as pot sizes grow, the need for liquidity might diminish.
Furthermore, private assets could serve as crucial components prior to and into decumulation, given their properties – particularly some private market asset classes’ potential to generate income, either fixed or inflation-linked. Stay tuned for more on this topic in our 2025 thought leadership.
In the chart below, we present a more detailed example glidepath that better suits schemes with an existing to-and-through glidepath, or those with in-house decumulation solutions. This could potentially bypass the need for full portfolio liquidity if members are not obligated to crystallise their pension pot.
Liquidity budget
We recommend assessing liquidity at the total portfolio level. The allocation to illiquid assets likely constitutes a relatively small proportion of total assets, in this case 15%. Correspondingly, the remaining 85% would be invested in liquid investments such as public markets and cash, which should satisfactorily cover any liquidity constraints.
It is also worth noting that private asset managers of LTAFs usually keep a portion of liquid assets in the portfolio – for example 10%, which would equate to 1.5% of our total hypothetical portfolio. This liquid allocation is used to provide periodic liquidity windows, allowing for withdrawals up to pre-defined limits on a monthly or quarterly basis.
To further determine suitability, schemes can undertake stress testing and shock analysis to assess how a sharp fall in equity markets would affect the strategic central allocation, and how a potential overweight to private assets can be managed over time. Read the full paper for more detail.
Fee budget
A key concern here is whether there is flexibility within the 0.75% fee cap, or if the need to maintain lower fees is a constraint.
In our scenario, assuming the current strategy's investment fees are 0.30% p.a. and that fees for the private market allocation are approximately 1.50% p.a., the total charge would increase to 0.48% p.a. for the whole portfolio. The pertinent question then for managers and trustees is: is the allocation expected to add value over and above the increase in fees?
One way to evaluate this is by examining the overall change in expected return, or in essence, looking at the overall expected quantitative gain. The chart below illustrates this, using the return assumptions detailed above.
Step 3: Selecting specific managers and funds
Upon affirming the potential role of private assets in a scheme and deciding on the investment amount, the subsequent challenge is selecting the right managers, funds and investments that provide the best fit. Key considerations here are set out below, with further detail in the full paper.
1. Fund objective/target: Does this align with your scheme's objectives?
2. Type of fund: Contemplate the various categories of private asset funds – and consider the potential to allocate to a 'multi-private asset' LTAF as a diversified entry point.
3. Types of investments and allocation: Examine the portfolio's allocation, including in-depth analysis of exposure across sectors, regions and asset classes.
4. Fee structure: Private asset investments can come with complex fee structures. However, many LTAFs offer a single ongoing management charge, greatly simplifying the typically complex fee structure and enhancing transparency.
5. Past performance: Always review the fund manager's track record. Additionally, assess performance against objectives over differing member entry and exit points.
6. Sustainability characteristics: Revisit understanding of how the fund integrates ESG factors into its investment decisions, including detailed assessment of how they monitor and engage with companies on ESG performance during the investment period.
Embracing the future
Although the adoption of private assets comes with its nuances and challenges, the potential rewards underscore the importance of embarking on this journey.
We encourage stakeholders in the DC scheme space to begin the dialogue with fund managers, investment platforms and advisers; take time to educate the scheme’s decision-makers on the value and implications of including private assets into the investment mix; and develop a clear, phased approach for potentially integrating private assets, considering the scheme's unique characteristics and broader market trends.
By taking proactive steps today, scheme managers and trustees can ensure they are well-placed to leverage the opportunities these investment vehicles offer.
Please note that this paper is for informational purposes only and should not be construed as legal, tax, investment, or financial advice. Always seek professional advice before making any investment decision.
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