Why private markets could spell bigger returns for pension funds


23 Feb 2024

Reforms in 2024 and beyond will open up huge growth potential for the pensions landscape, says Hugh Stacey.


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Reforms in 2024 and beyond will open up huge growth potential for the pensions landscape, says Hugh Stacey.

2023 was a reformative year for pensions, with UK Chancellor Jeremy Hunt unveiling new plans to enhance productivity and increase returns on pension savings.

The political push to encourage pension funds to invest more in private assets is set to continue throughout 2024.

In his most recent Autumn Statement, the Chancellor announced a sweeping package of pensions reform to enable pension funds to diversify their portfolios, invest in high growth companies, and drive a more consolidated pensions market – which could spell juicier returns for investors.

This includes plans to commit £250m under the Long-term Investment for Technology and Science (LIFTS) initiative, which will provide over a billion pounds of investment from pension funds and other sources into science and technology companies in the UK.

Aviva, Scottish Widows, Legal & General, Aegon, Phoenix, Nest, Smart Pension, M&G and Mercer pledged to allocate a minimum of 5 per cent of default fund client assets to investments in unlisted equities by the year 2030.

With major pension funds representing around two-thirds of the UK’s entire defined contribution (DC) workplace market, this represents an important commitment to provide savers with more exposure to private markets and forms a key component of the next phase of the Chancellor’s Mansion House reforms.

These reforms have the potential to help pension funds diversify their portfolios and achieve higher longer-term returns – bringing benefits to both pension savers and British economy.

However, the devil is in the detail: any push into private assets comes with a fair share of challenges, and the operational aspects of this push must be considered. 

Boosting investment in private markets

Concerns about UK pension funds’ lack of domestic exposure have been rumbling in the background for some time. According to the government’s Pension Charges Survey, about two-thirds of the UK’s DC pension scheme providers – the most common form of workplace pension – have zero exposure to illiquid investments in their default funds, while the remaining third have exposure of between 1.5% and 7%. The main barriers to investing in private markets relate to the high costs associated with these investments.

The need to diversify portfolios, achieve a premium on investment returns, and manage risk has been the driver behind the Chancellor’s push to get pension funds to invest more in private assets.

Yet statistics reveal that in 2000, 39% of London Stock Exchange shares were owned by UK pension funds and insurers. But by 2020, the figure had dwindled to just 4%.

The Capital Markets Industry Taskforce is also lobbying for consolidation across the pensions space, saying in a letter to the Chancellor last year that the UK’s DC marketplace was “highly fragmented by international standards” with close to 27,000 schemes, 25,700 of which are “micro schemes” of fewer than 12 members.

This all points to more pension fund capital flowing into UK private markets in the coming years – potentially from a consolidated number of large players. If done right, this means pension funds could diversify their portfolios, achieve a premium on investment returns, and manage risk.

Enhancing efficiency across the back office

However, as well as new investment risk considerations, pensions funds must consider the fact that this asset class may pose operational and back-office challenges. Most pension funds are accustomed to the standardised reporting of public markets.

In contrast, private market investments are much more difficult to benchmark, reporting is less frequent and the detail of reports varies greatly. Although the back-office functions may not be deemed critical on the surface, they play a crucial role in determining the success of investments. It is through these functions that we gain insights into whether these investments are performing well or not.

A high degree of specialism is also required. Private equity fund managers will often spend years working with a company and will have a deep understanding of how the respective markets behave. The chief executive of The Pensions Regulator, Nausicaa Delfas, emphasised the importance of trustees overseeing defined contribution plans to possess the expertise needed to assess more complex assets.

She further advised that if trustees lack the necessary expertise, they should consider consolidating or potentially winding up their schemes. Yet access to comparable data is a challenge, and unless pension fund managers and trustees can view and analyse that data, it will be like driving the car backwards.

It is unsurprising, therefore, that technology-driven processes play a crucial role in managing and administering alternative assets. As pension funds action the shift to private markets, access to timely and tailored portfolio information is critical.

Managers need actionable intelligence through intuitive dashboards designed for their specific requirements. This will empower them to manage their exposures effectively, assess the overall portfolio performance, and even forecast future valuations with ease.

New reforms in 2024 and beyond will open up huge growth potential for the pensions landscape and potentially boost British industry in the process. By working with expert providers, evaluating the performance of investments through an effective back office, and managing the complexities of private market data, pension funds can maximise the benefits – and overcome the obstacles.

Hugh Stacey is executive director of asset owner solutions at IQ-EQ.


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