Chris Inman: We could be witnessing the beginnings of the next failure of expectations for DC savers
As defined contribution (DC) schemes explore private markets and illiquid assets, it’s crucial to navigate this landscape with caution before diving in headfirst. Whilst only time will tell, I expect a specialist approach will outshine a generalist one in delivering better outcomes for members.
A tale of private markets
Great expectations are certainly what the defined contribution (DC) industry has for private market (or illiquid asset) investing. What exactly are we expecting? It's outperformance – relative to everything apparently. It's also lower volatility, capital losses, it could also be the saviour for UK economic activity… the list goes on.
Some of these expectations remind me of those held for diversified growth funds (and look how that turned out for most DC savers).
Before you get the wrong idea, as an Australian, I'm a big fan of private market investing but having seen it done well, and not so well, and having helped cleaned up the mess left by many private market funds post the financial crisis, I'm keen that DC investors go into any investment with their eyes open (there's some bonus information comparing the Australian and UK DC markets at the end for those interested).
Aon's DC Pension Scheme Survey (which can be accessed here) found that only 1 in 10 DC schemes currently invest in private markets but a number are either considering or need more information before investing, so they need our help.
The next failure of expectations
As Charles Dickens said in Great Expectations: "Take nothing on its looks; take everything on evidence. There's no better rule."
My concern is that we could be witnessing the beginnings of the next failure of (great) expectations for DC savers with all the hype that local managers are building around their private markets offerings.
Indeed, I wonder if there is a correlation between the number of self-serving social media posts and actual future performance of these funds? Does one fund manager have capabilities across the private markets spectrum? Only time will tell given very few managers that are launching so-called ‘DC friendly' private market funds (usually as a long-term asset fund (LTAF)) have a credible track record of managing these assets.
I am supportive of true diversification and investing with best of breed managers that help improve member outcomes. Private markets have a role to play in this but are not a homogenous group of assets. That is, we need to be careful to first understand what we are trying to achieve for DC savers, the trustees' beliefs, etc before committing capital to strategies that have long lock-up periods and sporadic liquidity. Asking these questions of yourselves means that some DC schemes won't have the ability or appetite to invest in such solutions and that's fine.
The questions to ask
There are also some very important questions, over and above the usual about objectives, people, process, etc, that need to be asked of these private market managers before investing, including:
- What is their performance track record of managing such assets/funds? Can they show actual historic returns?
- What is their record of managing liquidity and redemptions, including exiting holdings, particularly in periods of stress?
- How will they mitigate the j-curve as well as incentivising early investors i.e. what's in it for those diving in headfirst?
- If they have a master trust or own pensions arrangement, will they also be investing in the fund and if so, what fees will they paying?
- What is the amount of 'listed proxies" being used (e.g. investing in listed shares, in essence just equity market exposure, and dressing it up as ‘growth or private equity')?
- If there is a large use of listed proxies, why should I pay such high fees?
- What is the split between how much is internally managed (in-house) and externally managed (outsourced to other managers).
- For those using externally managed funds/managers, what extra fees will they be charging for the pleasure of their overseeing the portfolio for you?
- If in three to five years' time you haven't hit the strategic asset allocation shown to me, what compensation will my members receive?
- Is the performance profile being offered too good to be true? If not, is it sufficient in improving member outcomes to overcome the extra governance oversight, fees, potentially sporadic liquidity, etc?
Working with a specialist
As mentioned already, most of the managers launching private market funds for the DC market are generalists and large elements of their portfolios are made up of in-house or listed exposures. Few, if any, of these managers can claim to be leading in every area of the market.
Given this year's Olympic Games in Paris, a fun way of illustrating how generalists can fall short of specialists is by looking at the outcomes of the events in the decathlon (generalists) vs their standalone competitions (specialists). The below table shows how the results for the men's gold medallist at the Tokyo 2020 Olympics of the decathlon really don't come close to the gold medallist in each of the standalone events.
We believe that the best way to implement a private markets portfolio is through a truly open architecture solution that invests in best of breed manager(s) for each component.
Summary
In conclusion, this is a relatively new area for DC investing and there are no prizes for jumping in to be first. We must remain focused on what we are trying to achieve for DC savers and the investments that help us get there.
Chris Inman is a partner at Aon
Bonus Information - Australian superannuation vs the UK DC market
Superannuation asset allocation
Source: ASFA, June 2024
