Partner Insight: Closing the gap - why UK pension schemes can't afford to sit out private markets

UK pension schemes are sitting on a significant, and largely unclaimed, opportunity. Despite decades of evidence that private markets can enhance risk-adjusted returns, the UK's defined contribution (DC) pensions industry allocates just 3.5%^[1] of its assets to the asset class. Compare that with the 8% allocated by US pension funds, 20% in Australia, 18% in Canada and 15% in the Netherlands^[2], and the scale of the shortfall becomes clear. Even UK institutional investors more broadly allocate only around 12% of portfolios to private markets, lagging international peers.^[3]

That gap represents both a missed opportunity for scheme members and untapped fuel for the UK's own growth story. The government's Pensions Investment Review has identified the shortfall, and the Mansion House Accord, signed by 17 of the UK's largest workplace pension providers, commits signatories to allocate at least 10% of DC default funds to private markets by 2030, with at least 5% directed specifically into UK assets. Alongside initiatives from the British Business Bank, these tailwinds are helping to unlock a wave of investment in the country's most innovative sectors.

Federated Hermes Limited embarked on its first private markets investment in 1983 on behalf of one of the largest pension schemes in the UK. We believe schemes willing to close this gap will find a market shaped by structural forces that favour long-term, patient capital.

In private equity, the team believes the strongest opportunities currently sit in the lower mid-market. "Investors' historic focus on larger deals has meant that less capital is now chasing highly attractive opportunities in the lower mid-market, where we are identifying companies that are well positioned for growth and easier to exit," says Karen Sands, Chief Operating Officer, Global Private Equity. The team's UK investments span R&D, energy services, social housing and life sciences, with technology-enabled services (such as compliance software for financial institutions) among the highest-conviction themes. As a services-heavy economy, the UK stands to gain disproportionately from the productivity gains automation and AI are expected to deliver, and is already a European leader in AI adoption and the world's third-largest data centre market.^[4]

Infrastructure can offer a different but complementary case.  Against a backdrop of sticky inflation and elevated rates, regulated and contracted assets with strong inflation linkage have particular appeal. "We manage infrastructure investments across the UK and Europe, including UK holdings in the largest gas distributor, the largest port operator, a cross-Channel rail operator and an onshore wind farm," says Tom Bolton, Managing Director, Infrastructure. The UK's Clean Power 2030 Action Plan, one of the most ambitious in Europe, is driving demand for renewable generation, battery storage, grid modernisation and hydrogen. The team is meeting that demand directly through its acquisition of Rivington, a UK renewables developer with particular expertise in site origination and grid strategy, including for data centres.

Real estate completes the picture, with the potential to offer resilient income through the cycle. "If a building meets the social and economic needs of the people and businesses it serves, it will remain a durable and reliable source of income, regardless of market cycles," says Mark Russell, Chief Investment Officer, Real Estate. Over the past 40 years, 82% of total UK real estate returns have come from income^[5], underlining the case for well-let, well-managed assets in sectors with structural, non-discretionary demand: genuinely affordable housing, logistics, storage and healthcare among them. The firm's regeneration of Paradise Birmingham illustrates how this partnership-driven approach can deliver for institutions and communities alike.

For pension schemes, the case for action is building on every front: policy support, a maturing domestic opportunity set, and a persistent allocation gap relative to international peers. Closing that gap requires specialist knowledge, established networks and proprietary deal flow: precisely what more than 40 years' experience in deploying institutional capital across the UK economy is designed to provide. As the Mansion House Accord pushes the industry towards higher private markets allocations, schemes that move early, and partner with experienced managers, will be best placed to capture the returns premium this asset class has historically delivered, while playing a direct role in financing the UK's next phase of growth.

To discuss how your scheme can close the gap and access these opportunities, visit federatedhermes.com or speak to your Federated Hermes representative.

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