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Capital Formation: Investing Pension Contributions in Private Markets Responsibility

12 May 2020

Overview

Based on workshops held across Europe, CFA Institute research identifies the capital formation opportunities and challenges for defined contribution (DC) pension schemes amidst calls for greater private market access in Europe.

The number of public companies listed on public equity markets worldwide has experienced a significant decline in the past few decades. This development may reduce investment options and expected returns for retirement portfolios. One policy proposal being considered in many jurisdictions is to allow pension schemes, particularly defined contribution (DC) pension schemes, to invest relatively more in private markets. Private market investments, which tend to be more illiquid and to have a longer time horizon than public market counterparts, are considered by many to be suitable for diversifying pension savings exposures to public equity and debt markets and seem to promise higher expected returns.

This report looks at the current pensions landscape in developed markets to identify the benefits and disadvantages of DC schemes increasing their investments in private markets. The experience of defined benefit pension schemes, traditionally an active participant in private markets, is also considered. Finally, the pensions landscape in several European jurisdictions is presented to chart a plausible way in which these systems could interact with private markets.

The aim of this report is not to advocate for, or against, increased private market investments by DC schemes, but rather to identify the issues that would result should such a policy be pursued by a given jurisdiction. Specifically, we identify the following issues that need to be addressed when expanding DC scheme investments into private markets:

  • Value for money: The focus of regulators on low cost as the key metric of value for money may need to change. For example, charge caps, such as the one imposed on default funds under DC schemes in the United Kingdom, would need to account for the higher expenses involved in the structurally complex private market strategies.
  • Eligible assets: The universe of permitted investments on such funds as Undertakings for the Collective Investment in Transferable Securities (UCITS) or European Long-Term Investment Funds (ELTIFs) may need to be reviewed to enable DC schemes to participate in private market investments.
  • Disclosure: It is likely private market funds themselves will need to adjust their disclosures on costs and charges to increase the transparency of the fees paid by investors. It also may be necessary to review their traditional fee structure if attracting DC assets is deemed a priority.
  • Pooling resources: The issue of access is important even for large DC schemes because of the restricted nature of many private market funds. It seems likely that consolidation or pooling of small schemes would be necessary to generate enough scale to participate meaningfully in private markets. In the United Kingdom, efforts to encourage this trend through the Master Trust structure are ongoing.

CFA Institute Position

CFA Institute believes there is a plausible argument for increasing participation by DC schemes in private markets, although it is not as clear-cut as implied by some advocates of this policy. A sober realization is necessary, however, that such investments do not guarantee outperformance of public markets, and also that they come with significant risks and uncertainty for savers. These investments will challenge the existing daily liquidity paradigm that exists in the DC industry, something that, in any case, may be overdue.

There are a few ways to leverage existing products to increase access to private markets:

  • Expand the universe of eligible assets for ELTIFs or create a similar non-infrastructure asset wrapper;
  • Expand the use of tax-advantaged investment accounts that use lengthy lock-up periods to reduce the liquidity mismatch problem of investing in private markets;
  • Expand the ability of DB pension and insurance funds to invest in private markets; and
  • Expand the ability of DC pension funds to offer non-default fund options with significant allocations to private markets.

View the full report (PDF)