DC schemes target private markets as room for illiquid assets increases

Despite concerns that less liquid asset classes can be complex and expensive to introduce to DC portfolios, Hymans Robertson has said up to 40 per cent of default assets could be allocated to illiquid investments.

MandateWire data show that private market allocations accounted for almost 46 per cent of all investments* made by DC pension schemes last year (to December 7), up from 23 per cent of investments made in private markets in 2019.

Larger DC schemes led the way in private markets. For instance, the £1.5bn Smart Pension master trust introduced private market illiquid assets into its default fund with the help of Natixis Investment Managers in early 2021.

The £100mn MV Dual Credit Fund, which blends European leveraged loans with a global multi-asset credit strategy, represented 10 per cent of the default fund’s assets and gave the master trust access to private credit.

Paul Bucksey, managing director of Smart Pension, said the credit fund opened “illiquids to mass market DC in an accessible and affordable way”.

“We believe this should improve returns and reduce volatility for members of the master trust,” he added.

Infrastructure manager hires

The circa £20bn Nest was a major contributor to the £1bn inflows into private markets last year, as the trust appointed a number of unlisted infrastructure managers.

It hired Octopus Renewables for an initial £250mn commitment, which will potentially be extended to £1.4bn by the end of the decade.

CBRE Caledon — the private infrastructure investment subsidiary of CBRE Global Investors — and GLIL Infrastructure were also awarded infrastructure mandates worth around £400mn and £250mn respectively.

Stephen O’Neill, head of private markets at Nest, said the trust was seeking “the best risk-adjusted returns”.

“We believe direct infrastructure equity investments can offer diversification benefits and a return premium to public market equities, at lower levels of risk,” he said.

Space for pricier markets

While many DC schemes are wary of making private market allocations because of daily dealing and liquidity requirements, Hymans Robertson said it is possible to combine illiquid assets with more liquid asset classes in blended funds or blended pooled funds, like Nest and Smart Pension have done.

The consultancy noted in its recent paper on illiquid investments for DC schemes that assets such as private equity, private debt, infrastructure and real estate are generally more expensive than listed and liquid strategies. However, it urged DC schemes to consider member outcomes in their allocation decisions.

“Our analysis suggests that charges for the average DC scheme are between 0.3 per cent and 0.4 per cent, despite the current charge cap of 0.75 per cent. This means there is plenty of headroom to allocate to more expensive markets,” it said.

Callum Stewart, head of DC investment at Hymans Robertson, said DC schemes risk missing out on opportunities to improve diversification and member outcomes if they shun illiquid assets.

“We would urge the DC sector to revaluate their perceptions and challenge pre-existing beliefs for the benefit of members,” he said.

Emerging ESG opportunities

Hymans Robertson has advised DC schemes against selling liquid assets to fund illiquid allocations. Instead, schemes should use incoming cash flow to build these allocations.

Stewart said schemes could allocate up to 40 per cent of default assets in illiquids in the earlier stages of the savings phase.

“We would expect the norm for the majority of schemes to be around 20 per cent, and are already seeing examples of master trusts with allocations close to this level,” he noted.

MandateWire data show UK DC schemes have also been slowly increasing their exposure to responsible investments, with 36 per cent of all DC investments tracked last year targeting funds that integrate environmental, social and governance factors.

Stewart said specific ESG-related investment opportunities were also emerging in private markets as part of the transition to a lower-carbon and socially just world.

“We therefore have a unique opportunity to not just improve retirement outcomes, but improve engagement levels using illiquid investments,” he added.

*Investments comprise the number of awarded mandates and asset reweights tracked and reported on by MandateWire.

This article originally appeared on MandateWire.com