Private markets and DC member outcomes: Is the ‘juice worth the squeeze’?
There is a growing focus on DC pension schemes broadening their portfolio allocations to include private market investments. For trustees the key consideration is the impact this can have on retirement outcomes for their scheme members.
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In our previous white paper, we explored how defined contribution (DC) pension schemes can begin their journey into private markets. This focused on three key steps: assessing the suitability of private assets for a scheme’s specific needs; determining a sensible target allocation aligned with risk tolerance, return objectives, and illiquidity budgets; and conducting rigorous due diligence to select the most appropriate funds and managers.
This discussion was set against a backdrop of increasing change across the DC investment landscape – and that has only intensified in recent months.
Investing for growth
Several UK government initiatives are actively encouraging workplace pensions to allocate more of their capital to long-term investment strategies with the potential to enhance economic growth over the long term. These include the new Mansion House Accord and Pensions Schemes Bill, which respectively seek to catalyse greater investment from DC schemes into private markets and propose structural reforms to make this more viable over the longer term.
The strategic direction is clear: policy is aligning with investment practice to encourage DC schemes to explore the long-term return potential of private markets, in order to both support long-term economic growth and, more importantly, improve outcomes for millions of pension savers.
This last point is key and reflects the fundamental question facing trustees: will including private markets in their default investment strategy benefit members in relation to their retirement outcomes? Or, to put it more plainly: is the juice worth the squeeze?
Understanding the trade-offs
We know that private markets investments typically target – and have historically delivered over almost all long-term periods, on average – enhanced returns compared to public market peers. This reflects the premium paid for illiquidity and complexity, as well as the broader opportunity set and differentiated sources of alpha.
We also know that private markets typically come with higher fees, as well as specific complexities and additional risks for those looking to allocate.
In an effort to understand how this translates to member outcomes in practical terms, we have created a hypothetical case study, using real investment projections relating to real funds. The aim is to showcase the potential at-retirement benefits for actual pension savers that can be achieved by including private markets in a default investment strategy.
Introducing Lucy
Meet Lucy, a new starter and Junior Consultant at the company sponsoring our hypothetical pension fund. She earns £35,000 a year and has a current pension pot of £10,000, which will grow through annual company and personal contributions totalling 10% per year.
For the purposes of simplifying the illustration, we have assumed Lucy’s salary grows at 3.5% per year and her contribution rate remains fixed at 10% throughout the accumulation phase, which runs for 40 years from this start point to enable her to retire at 65.
Her scheme’s existing default strategy follows a typical design: 90% allocated to global equities and 10% to fixed income (corporate and government bonds). As she nears retirement, the strategy will gradually shift, reducing equities exposure and increasing allocations to bonds and cash.
Introducing Private Markets to the glidepath
The scheme is now enhancing the growth phase of the glidepath by allocating 10% of the portfolio to private markets. This allocation is funded by reducing the equity component and is implemented via a semi-liquid, multi-asset Long-Term Asset Fund (LTAF).
LTAFs are designed to make private market strategies more accessible to DC schemes, offering simplified investment routes and periodic liquidity. You can read more about LTAFs, as well as other so-called ‘semi-liquid’ private market investment options, by clicking here.
For the purposes of our illustration – and, again, to keep things simple – we assume the private market allocation is fully divested by retirement and that the at-retirement allocation remains otherwise unchanged (see charts).
Retirement glidepath for current vs new allocation based on years to retirement
Source: Schroders. For illustrative purposes only.
It’s worth noting that the assumption of fully divesting private markets in order to have appropriate liquidity approaching and at retirement is not beyond challenge. Income-focused private strategies and the diversification benefits these asset classes can bring could justify a more extended role for these investments post-retirement. We will explore this topic further in a future paper.
Projected outcomes: Ongoing costs are expected to increase…
As noted and would be expected, adding the LTAF to the default investment strategy has increased the overall fee payable by members.
In this example, the LTAF charges a management fee of 1% per year. With a 10% allocation to this fund in the growth phase, the overall annual fee increases from the current 0.30% to 0.37%. In monetary terms, Lucy’s average annual fee, over the 40-year period, rises from £680 to £910 – an increase of £230 per year.
… but the potential rewards are even greater
The target return of the LTAF is 8-10% per annum, net of charges, which we have assumed to be achieved on average over the life of the investment (for this illustration, we have assumed net returns in the mid-point of that range). This increases the projected performance of the portfolio, with the average annual return over the 40-year period rising from 6.1% to 6.5% per year.
The result? Lucy’s retirement pot grows faster, with the increased return delivering an estimated additional £27,000 worth of savings in aggregate to take her final estimated at-retirement pot size to £397,000 (see graphic).
Expected at-retirement benefit under new default strategy
Source: Schroders. Assumes average return of 9% net of charges for LTAF added to default strategy, reflecting the mid-point of the target 8-10% return. Full list of assumptions available on request. For illustrative purposes only. Past performance is not indicative of future results and cannot be guaranteed.
When this is converted into retirement income via an annuity, the difference becomes even more tangible. Lucy’s annual income in retirement is projected to rise from £28,800 to £31,000, an uplift of £2,200 per year. These increases are all net, so reflect the impact on retirement outcome after accounting for the additional fees noted above.
Conclusion: Is the juice worth the squeeze?
For Lucy, and in this example, yes. Over a 40-year period, Lucy could expect to achieve an increase in retirement income of approximately £2.2k per year, over and above the additional costs of £230 per year.
This illustration highlights that incorporating private markets into a DC default strategy has the potential to deliver meaningful improvements to member outcomes. But such a move requires more than just a shift in asset allocation – it requires thoughtful planning, robust governance, and a willingness to engage with the operational implications.
The strategy must be tailored to each scheme’s unique characteristics; liquidity constraints, member demographics and platform capabilities all need to be considered. Trustees must also recognise the importance of manager selection and transparent communication with members about the nature and benefits of the investments.
Moreover, it’s essential to avoid treating private markets as a bolt-on. Their inclusion should be integrated into a coherent, long-term investment framework that aligns with the scheme’s objectives and glidepath design.
But, when implemented thoughtfully and in line with scheme-specific needs, it is clear that there is the potential for private markets to enhance returns, improve diversification, and ultimately support members like Lucy in achieving better outcomes in retirement.
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