How global pension funds have been investing in private markets
Having spent the last 12 months in the United Kingdom as head of defined contribution investments at a large pension consultancy in London, I was surprised at the striking similarities between the South African and the UK pension industries – in particular, the interest in private markets.
In SA most institutional investors remain under allocated to these investments – unlike their global counterparts.
Private market investments generally include private equity, infrastructure, private real estate and private debt. They offer the potential for greater diversification, an illiquidity premium, protection from market volatility and compelling risk-adjusted returns.
Retirement fund liabilities are long-term, which makes these types of investments well suited to meet their long-term obligations.
Lessons from abroad
Globally, retirement funds have been investing in private markets for years. In the United States and Australia, allocations can reach as high as 30%, specifically in private equity. If we look at the long-term risk-adjusted returns of private equity, it is difficult to argue against the inclusion of this asset class as part of your investment strategy.
Investing in private equity also enables the process of unlocking and deploying capital to high growth companies, especially those in the fintech, biotech, life sciences and the clean technology space. These types of investments contribute to economic growth and further provide benefits in terms of environmental, social and governance (ESG) integration.
Private markets come with their challenges and although the interest of retirement funds in these types of assets has increased, adoption rates have been low. Some of the reasons include a lack of familiarity and understanding as well as higher costs.
Liquidity is also a challenge, as these types of investments are illiquid and not generally able to meet the cash flows of a defined contribution fund. To address this, the vehicle in which these types of investments are held, must be structured to allow for liquidity.
To deal with the liquidity constraints, the UK has introduced a new investment vehicle known as a long-term asset fund (LTAF). LTAFs are new investment structures designed to provide easier and simpler access for defined contribution investors to access long-term private market investments. Europe follows a similar structure with the European long-term investment fund (LTIF).
The fund is evergreen and provides access to long-term investment opportunities and a full ‘look through’ to the underlying investments.
Liquidity is generally achieved by providing a high level of investor protection and an alignment between the liquidity of the asset base with the frequency of redemptions offered to investors. This is achieved through the deployment of carefully considered liquidity management tools.
Another way of solving for liquidity is through an investment platform. The right platform provider will be able to accommodate and manage ‘illiquid’ funds, which typically have non-standard dealing and pricing cycles, including trade notification requirements and liquidity constraints.
Some of the leading asset managers in this space offer private market multi-asset funds. To address the liquidity requirements, these managers generally hold a substantial allocation to cash which can make up 20-30% of the fund.
In terms of allocations, US private equity has historically outperformed EU and UK private equity. Geographical exposure is therefore important and should be aligned to your long-term capital market assumptions.
In the last two decades, private equity has generated significantly higher returns in comparison to traditional equities. While both markets have become much larger in volume, the spread in returns between the two is obvious and will likely continue to widen in the future.
Private equity has historically provided returns similar to that of Emerging Market Equities and higher than all other traditional asset classes. Its relatively low volatility² coupled with its high returns makes for a compelling risk-return profile.
SA’s outlook
With the recent changes to Regulation 28 of the Pension Funds Act, retirement funds can now invest 15% in private equity and 45% in infrastructure. This is encouraging, as retirement funds can now make meaningful allocations to private markets.
The SA retirement fund industry is in an exciting place. Private market funds should gain more traction as the focus moves away from investing in traditional asset classes to assets providing an illiquidity premium. We should also expect more innovative structures being developed to accommodate these types of investments.
Private markets are not looking to replace traditional asset classes, but should rather be viewed as a complementary strategy to public market exposure.
I look forward to seeing more allocations to private markets in the future, which should ultimately improve members’ outcomes at retirement.
