The Mansion House milestone

The Mansion House Accord and Pensions Bill are expected to substantially increase workplace pension scheme allocations to private markets, if the supply of attractive opportunities needs to be carefully managed

The signing of the Mansion House Accord in May was a big moment for DC pension fund investment in private markets. 17 workplace pension providers, representing approximately 90% of active DC savers, voluntary committed to a 10% target allocation to private markets, with at least 5% in the UK, by 2030. In addition, some leading master trusts have recently boosted their targets to 20% or even 30%.

The accord is being accompanied by the upcoming Pensions Bill, which sets out the government’s intention to double the number of £25 billion+ megafunds by 2030 and “secure over £50 billion investment in UK infrastructure, new homes and fast-growing businesses”. It also includes a reserve power to mandate allocations in the future. Meanwhile, the recent Pensions Review outlined the government’s preferred areas to receive investment.

Anthony Ellis, head of investment strategy and a partner at Hymans Robertson, says the push towards private markets is a “positive development” for DC pensions. “A whole subset of potential investments is currently not being accessed,” he says.

The government is backing private markets to boost UK growth in its preferred areas as well as potentially pension outcomes by £12,000. “Whatever its motivation, the outcome can be positive for members, although not necessarily for all schemes and in all circumstances. The devil is in the detail, across asset classes, governance, costs and fees,” he adds.

Paul Francis, principal investment consultant at Quantum Advisory, says: “Private markets can be a great addition to a portfolio. They can really help the wider portfolio in terms of returns and diversification, so I’m fully on board with them,” he says.

“However, if private markets and infrastructure are so attractive, why is it necessary to direct capital to them with the accord? Wouldn’t it flow naturally? Schemes have a fiduciary duty so, if an opportunity is compelling, we don’t need an accord, and certainly not mandatory allocations.”

Francis notes challenges in a couple of areas, including the capacity of some private markets to absorb substantially more capital as well as how to define UK assets. “Does it have to be run in the UK, domiciled in the UK, or generate its revenue in the UK?”

Suzanne Rose, UK DC leader at Mercer, says she is “supportive of private markets in DC solutions” and the accord. However, she adds that “I don’t think success can be banked just yet, without concerted effort in a number of areas.”

She says there “absolutely must” be a pipeline of good, investable opportunities. “We will only invest in the UK if we are confident, in line with our fiduciary duty, that solutions deliver better outcomes than any other alternatives.”

The accord also recognises the need for a shift of focus from cost to value, which Rose says must be realised. “We must make sure a fee budget is available to invest in good quality opportunities as well as governance on an ongoing basis. Otherwise, it will be difficult to get the solutions we need and drive good-quality outcomes,” says Rose.

“We’ve seen private market investments deliver good member outcomes in other jurisdictions including Australia. But we must make sure we invest in the right opportunities, to bolster UK economic growth and deliver member returns.”

Veronica Humble, CIO of master trust Cushon, notes that the commitment is voluntary and remains subject to fiduciary duty. “We believe there is a strong case for it at the strategic asset allocation level, but the individual investments still need to stack up,” she says.

Even before the signing the Mansion House Compact, Cushon had one of the highest allocations to private markets. “Primarily because the investment case is strong, but also because these types of assets have the ability to create emotional connections with pensions savers, which increases engagement,” says Humble.

The megafunds era 

Private markets will only be able to maintain attractive returns if the pipeline of suitable assets matches demand in the run-up to 2030. “At the moment, we don’t have concerns around the availability of investment opportunities,” says Cushon’s Humble.

She says that the Government’s growth agenda and push for private markets aligns with its investment strategy. “The investment opportunities are there… and the accord is quite clear in terms of the Government agreeing to facilitate a pipeline of UK investment opportunities.”

Rose notes that while investable opportunities exist, “the market needs to grow to get to the scale the government is hoping for… we hope that this will be the case”.

She adds that the government outlined “a whole plethora of opportunities across a whole range of different areas” in the final chapter of the Pensions Review. “That’s certainly what government is indicating it would like to make available,” she says.

However, schemes need to be wary of making long-term investments that align closely with the preferences of whichever party happens to be in power. Governments could potentially direct money to support its ideological goals, which however well-intentioned may not be shared by its successor.

“Master trusts need good governance around this,” says Ellis. “UK pension savers have no idea who the CIO of their master trust is – but I suspect that may change. They might become well-known and closer to the political sphere. Perhaps that would be healthy.”

The long-delayed development of the HS2 railway does not provide much reassurance for government-led infrastructure projects and “some PFI initiatives haven’t covered themselves in them in glory”, notes Francis.

Megafunds will need very large projects if they are obliged by agreement, or later mandate, to allocate 5% of their assets to the UK. “You would need government-sized projects to be able to deploy that money. And the government would decide which projects would be moving forwards,” says Francis.

Uneven impact 

More than £100 billion will head into private markets from UK DC funds over the next couple of years, predicts Ellis. This money is also likely to be unevenly spread among asset classes, which in turn have differing abilities to absorb capital.

Private credit is probably large enough to swallow latent demand, notes Ellis. “But what’s the universe for UK-based infrastructure projects or venture capital (VC)? In a world where lots of new money is chasing assets, the natural consequence is that not everyone’s going to end up with brilliant investments.”

Whether a wave of new money will push down private markets’ returns is “a very valid point”, says Francis. He notes that it is not just DC funds being encouraged into the sector – LGPS funds are also investing hundreds of billions into local infrastructure and development projects. “There’s potentially a lot of money heading into markets that do not have deep capacity,” he adds.

The private markets opportunity set is also different in the UK compared to other parts of the world. Therefore, says Francis: “If allocations are constrained to the UK, can you source good-quality, high-returning, reliable assets to the extent you need for your flow of capital? Are they optimal from a global allocation perspective? I’ve yet to see any compelling evidence to suggest UK private markets returns are stronger than in other regions.”

To achieve the government’s aim of boosting UK growth, companies of all sizes and maturities will need investment. Ellis notes that the scale of megafunds will likely rule out them investing in certain asset classes. “If we end up with a handful of megafunds, it’s hard to see why they’d be interested in making small investments in early-stage VC. They would need meaningfully sized investments to move the dial, which would crowd out smaller opportunities.”

On the other hand, many commentators have noted that while the UK has been very good at seeding new companies it has not been as good at scaling them. Megafunds could potentially fill the scale-up gap and keep companies in the UK.

Bobby Riddaway, managing director of HS Trustees, notes that UK companies that are ready to scale up “could expect twice as much investment if it went to the US instead… so that is what a lot of companies currently do”.

Smaller schemes

Mercer’s Rose says single-employer schemes will need to “take a long, hard look” at whether they can commit for the long term. “The government is inadvertently lifting the bar for single-employer schemes – they need to perform as well as the megafunds or they should be in one,” she says, predicting a dramatic reduction in their number. “The first consideration is whether there’s a good reason to hold out.”

Small schemes may not have the governance budget and the expertise to find optimal solutions, says Ellis. He is concerned most would end up in multi-asset LTAFs, with a range of exposures that are only unified by their illiquidity.

“These schemes are likely to look to the solutions available on their existing platform, which may only offer a small selection of multi-asset LTAFs,” he says. “It’s not clear all of them want a multi-asset one-stop-shop. If they want private credit private but not private equity, how do they achieve that?”

The closest equivalent to LTAFs in public markets is diversified growth funds, which Ellis notes have a poor track record for dynamic asset allocation. “In illiquid asset classes, is a manager going to be any better at allocating, when it’s harder and there is less flexibility?”

Joshun Sandhu, head of investment solutions and partnerships at Mobius, says schemes have alternatives to the LTAF structure and platforms such as his can provide access to a wide range of private markets funds. “Our general approach is to blend whatever assets the client wants into a structure,” he says. “It’s happening on the illiquid side as well. If schemes are limited to a few LTAFs on their platform, it could [use another platform] to access to the whole market.”

Sandhu expects master trusts to consolidate to approximately ten megafunds but also for lots of £1+ billion single employer trusts to continue operating. While most of Mobius’ private markets business has been with master trusts, Sandhu says, “I think demand will continue to develop” from single-employer trusts.

“I think we’ll see developing demand from DC schemes in the hundreds of millions… unless they are thinking about consolidating [into a master trust],” he says. “We could comfortably put a £300 million single-employer trust into a range of existing private markets funds.”

The road to 2030

The reserve power in the Pensions Bill to mandate DC schemes to invest in private markets presents a range of possible negative consequences. It could create “real risks in the system”, according to Rose.

“We’re all bidding for the same private market opportunities, and if that pipeline is squeezed it could have an unequal impact on supply and demand… and lead to a significant erosion of trust in the pension system.”

Ellis does not think so-called mandation will happen. “There’d be a lot of unintended consequences. Other jurisdictions, such as Australia, haven’t gone that far but have achieved benefits from home-bias investing. But there could be tax breaks, co-investments or other incentives.”

Riddaway says mandating allocations would be counterproductive, especially if asset allocators are already committed the energy transition. “It could be a risk,” he says. “It could make people reluctant, especially as they’ve got a fiduciary duty to members.”

Rose says mandation will not be necessary if the promised attractive pipeline of investments and enlightened approach to fee budgets materialise. “If the government creates a positive business environment and is willing to incentivise value creation in some way, mandation becomes irrelevant,” she says. “We are absolutely adamant that the principles of fiduciary duty and Consumer Duty have to be preserved.”

Whether an accord signatory or not, master trusts and DC schemes may find themselves under pressure to invest in private markets sooner rather than later. The provision of a reserve power in the Pensions Bill means that schemes could be compelled to invest later – perhaps at a sub-optimal point. And the artificial home-market bias in the accord may lead to vigorous competition for suitable UK assets.

“Pension scheme may have to get assets on the ground quite quickly before the opportunities dry up or become overvalued,” says Sandhu. “It will be interesting to see what happens to UK valuations If there’s a rush to get into assets. Will there be enough supply? Will valuations jump now and fall later? It comes down to whether the government and asset managers can supply enough opportunities.”

“We’re all in the market now, looking to fulfil our commitments to the accord,” adds Rose.