Private markets look set to overturn DC tradition 

Long Term Asset Funds (LTAFs) are increasingly becoming a hot topic within the defined contribution (DC) pensions industry, given their potential to accelerate DC investment in private markets. DC trustees attending the Mercer 2023 UK Pension Investment Conference in September were asked: would you feel comfortable for your scheme to invest in private markets today? On a show of hands about half said yes.

Just a few LTAFs have been launched so far, with others awaiting approval. First introduced as a fund vehicle in November 2021, LTAFs are intended to make access to private assets like infrastructure, private equity, private credit and real estate easier and simpler.

At Mercer, we are one of nine signatories to the Mansion House Compact that commits to increasing unlisted equity allocation in DC default funds to 5% by 2030 (our commitment applies to the Mercer Master Trust). Why have we signed up? To improve member outcomes in terms of investment returns and diversification of risk, as well as access to a greater range of investment opportunities. However, we recognise that some of the operational and other issues that LTAFs are designed to overcome remain.

What’s held DC funds back from taking advantage of private market opportunities is largely down to the practical issues surrounding implementation. For a start, private market investment fees are higher than those for public markets. With the DC default charge cap and increasing regulation over the years to push for lower fees, private markets have been seen as prohibitively expensive for DC investors.

Another key issue around fees concerns the use of performance fees, and how best to apply these in a way that are fair to members. Then there are operational challenges, especially related to the limited liquidity and infrequent valuations of private markets funds, as compared to traditional DC funds that have daily liquidity. This represents a challenge as DC platforms and administration processes have traditionally been built around liquid, daily dealing funds. Finally, from a governance perspective some DC trustees are wary of private markets as they are not familiar with the intricacies of private market funds and how they operate.

So, to what extent have LTAFs overcome these obstacles? While LTAFs have been designed to try and mitigate some of these operational challenges, some issues still remain. In particular, potential issues around redemption notice periods, ‘lock-in’ periods and relatively high fees may limit the scope of DC investment. Furthermore, adoption of LTAFs is dependent on investment platforms and administrators adapting their processes to accommodate non-daily dealing funds, which is a developing area.

Overall, Mercer welcomes the discussion around incorporating private market assets in DC, and recognises the investment case as a way of improving member outcomes. What’s more, it is to be welcomed that the industry is moving on from focusing purely on fees, to a more holistic view of value for DC members. Through becoming a signatory of the Mansion House Compact, Mercer aims to further encourage this focus, and drive forward finding viable solutions.

From 1 October 2024, all trust-based DC schemes must have an illiquid investments policy within the Statement of Investment Principles. Given that private market investments are generally illiquid, this means the appropriateness of private markets is an area that all DC schemes must consider looking forward. 

DC trustees keen to explore investing in private markets should collaborate with their investment consultant to understand more about the asset classes available, their relative characteristics and how they can be used to enhance value for members through the investment strategy. Engaging with investment platforms and managers is also key, to understand the practicalities of implementing private market investments.

This article is based on the presentation made to Mercer’s 2023 UK Pension Investment Conference.