Dermot Courtier: Scale can help unlock the investment potential within private markets
Interest by investors in gaining exposure to private markets has seen significant and well-documented expansion over the past ten years.
Yet until recently, there has been limited application within the defined contribution (DC) market. To date, the demand for private market assets has largely been the preserve of other institutional investors such as defined benefit (DB) schemes and insurers.
This is fast beginning to change, however, with the investment case for illiquid assets becoming an increasingly important consideration for DC default strategies and master trusts, in our view.
This acceleration in interest can be attributed in large part to the investment potential within private markets - DC schemes could benefit from the diversification and risk-return profile that they offer. There is also the government's desire to unleash the potential of DC institutional capital in support of the levelling up agenda, which investing in private markets can contribute to.
The Legal & General Mastertrust has increased its exposure to illiquid assets and started to incorporate private assets within its default strategy though LGIM's target-date funds, giving members private market exposure as part of their journey to retirement. We have done so because we believe there is now a very real opportunity to incorporate private asset allocations into default DC strategies in order to improve potential outcomes for savers.
Assessing the benefits of private markets
There are several potential benefits for DC schemes when considering private market allocations, in our view, such as portfolio diversification by accessing asset classes not fully covered by listed options, enhanced yields and the provision of stable income. While diversification is no guarantee against a loss in a declining market, we believe it can be particularly valuable in the current climate, where traditional assets such as public equity and public fixed income are showing stronger correlations to each other and considering the series of headwinds facing the global economy.
One of the most common reasons cited for allocating to private markets is the potential for higher returns through what is known as the illiquidity premium (many of the assets are not easily bought and sold, meaning investors can be tied in for longer). As a result, there is often an assumption that this illiquidity means the core role of private markets when investing for retirement is geared more towards an allocation for younger cohorts looking for capital growth.
Yet this doesn't have to be the case. We are seeing a role for private markets with the older cohorts within our master trust - those who are close to retirement - who should stand to benefit from gaining exposure to asset classes such as short-dated credit. As the opportunities for portfolio diversification and volatility reduction within private markets continue to rise, this will lead to the exploration of a wider universe of private markets opportunities within DC.
Scale is key to promoting better member outcomes
One source of scepticism when it comes to DC allocations to private markets, however, is the issue of cost. Private markets can be more expensive to invest in than public assets, like listed equities and government bonds, and this challenge of higher costs can be difficult for trustees of DC schemes to balance alongside the uncertainty of an improvement in outcomes.
Long-term value for money must always be a key consideration for DC pensions so it is vital that return expectations are balanced against the cost of investing and administration. This is why we believe the scale of the master trust structure can be so valuable in unlocking the investment potential within private markets. It provides the breadth and size needed to keep costs down for members, while still accessing the potential benefits that illiquid assets can offer.
As the regulatory and industry focus on value for money continues to evolve, the DC industry needs to consider how best to balance the cost of investing in different asset classes - which scale can help to keep competitive in the case of private assets - with delivering robust investment performance in a variety of market conditions and at all stages of the member journey.
Achieving that balance will be key in helping to drive a more holistic understanding of what "value for money" really means. We expect DC allocations to private markets to form an important part of this conversation over the coming years in terms of promoting better member outcomes.
Dermot Courtier is independent chair of the Legal & General Worksave Mastertrust
