PI Partnership – BlackRock
For professional investors only
DEFINED CONTRIBUTION AND PRIVATE ASSETS: WHAT INVESTORS NEED TO KNOW
With contributions into defined contribution pension schemes only expected to grow and with it being a disappointing period for equities, more and more investors are turning to private market assets for the growth they need. portfolio institutional spoke to BlackRock’s David Lomas to find out what defined contribution investors need to know before building a portfolio of illiquid assets.
What role do private assets play in defined contribution scheme portfolios and where do the opportunities lie? “We are seeing huge demand for private market assets from the pension commu- nity, including defined contribution schemes. If you look at the market tur- moil we have seen, the traditional 60/40 portfolios would have underperformed significantly this year. “This has caused schemes to look outside the traditional asset classes, driving an enormous demand for alternative assets. Why? Well, private markets can offer investors diversity of sectors, geography and companies at different parts of the growth cycle. However, there is no one- size fits-all solution. Private market assets are not homogeneous. Schemes will have different objectives with varying con- straints and investment beliefs, which means how and when they will adopt pri- vate markets might differ. “Number two, a huge demand for income. Obviously, interest rates rising cushions some of that need, but we’re still seeing massive demand for income. “The third is return. People are looking for elevated levels of return to try and grow their savings pots. As you have seen this year, demand for portfolio resilience is huge. And, if you look at the data going back over 10 years, private market assets have shown a lot more avoidance of down- side risk, which provides more resilience into portfolios. “But what is most interesting is that the private markets offer the chance to invest
in opportunities that do not exist in the public markets. For example, we have closed a transaction with Vanguard Renewables, which turns food waste and manure into energy. This company, which you cannot buy in the public markets, has a created a solution to not only reduce landfill and generate renewable power but also to reduce the carbon emissions pro- duced from waste. “From our perspective, there are some interesting opportunities that you just do not get access to in the public markets. And this is why we believe defined contri- bution schemes should be a participant in private markets.”
What should defined contribution schemes consider when allocating to illiquid assets? “We have a fiduciary responsibility to pen- sion savers. We have to think about what the investment return is, what the invest- ment objective is and make sure we are driving towards the right outcome for those savings.
“I start from that premise. But what frus- trates me, and a lot of the industry, is that there is too much focus on fees. If I was looking at a 1% improvement in return over 40 years, and compound that, that would a 50% improvement in the return profile for the saver. If you want access to these interesting ideas, we have to look at the cap on fees. There is a lot of work and discussion going on in this area, but we need to move the debate toward what is the net return to the investor.
16 | portfolio institutional | December-January 2023 | Issue 119
“We produce capital market assumptions, and over a five-to-10-year period, private market returns are higher than for the tra- ditional fixed income and equity strate- gies¹. Defined contribution schemes not participating in private markets are, there- fore, not getting the opportunity to have those elevated returns.
“The second part is, if you are going to design a solution, you have to think about private markets in the construct of the whole portfolio that the customer is invested in. As you get closer to retire- ment, you typically want to crystallise and protect the value created. “So, when you think about the whole port- folio, private markets need to form part of that journey to make sure the experience of the saver is as intended: first for stabil- ity, and then income generation.” Lomas then listed the five key considera- tions everyone should think about when allocating to illiquid assets. “Number one, what is your investment objective? As a trustee of a scheme setting the invest- ment strategy, the fiduciary standard you have is to define what is a good invest- ment outcome. “Two, how are you going to build that portfolio. It is not as simple as putting a bit of private equity, a bit of real estate, a bit of infrastructure and a bit of credit into a portfolio and hoping it works. You have to think about the building blocks and how they work together with the liquid part of the portfolio, which would typically be the dominant allocation for a pension scheme.
“Three, is understand the scheme’s risk/ return profile. This helps you design something that will evolve through time to meet the demands of the members. “Four, there are concerns it is getting more competitive to find deals to invest in. So going through the traditional meth- ods of sourcing deals – the public tender process – is not the way forward. “From our perspective, having a sourcing edge with your partners is critical. How are the managers that you are working
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52
