More pension fund investors are looking to private markets. But this hugely diverse asset class doesn’t come without complexities and risks.
Investors are navigating through a transformative era as the period of steady growth known as the great moderation concludes. BlackRock has pinpointed five key mega forces that are reshaping the global landscape: digital innovation and artificial intelligence, the transition to a low-carbon economy, varying demographic trends, the evolution of finance, and increasing geopolitical divisions. These shifts pose numerous questions for defined contribution (DC) pension schemes seeking better diversification and high risk-adjusted returns. It is imperative for trustees to diversify investment strategies to safeguard members' retirement incomes.
In these uncertain times, private markets are becoming a popular choice for those looking for more solidity. This label covers a broad set of assets, ranging from venture capital to real estate. These assets could offer potential help for those making portfolio allocation decisions against a difficult global backdrop.
At BlackRock, we believe that now could be the time for DC schemes to take a further look at private markets – educating themselves around how to make the most of these assets and how to mitigate some of the liquidity challenges they pose.
Diversification and asset allocation may not fully protect you from market risk.
Why might now be the time to look at private markets?
Much as we wish for a smoother ride after the uncertainty of recent years, experts are predicting further volatility.
DC schemes must also deal with the impact of inflation on returns for their members.
Inflation seems likely to soften from the high levels we’ve experienced in recent times. However, it is still expected to remain above the levels we have been used to post-2008 in the medium to long term – this must be taken into account when making investment decisions.
Investors tend to value private markets for three main reasons:
1. Diversity
The private market sector is a broad church, so those wanting diversification are likely to find it.
In the USA, for example, there are around 5,000 listed companies, but approximately 36,000 venture capital-backed companies – and 16,000 private equity-backed businesses. For this reason, the potential for diversification, both by sector and region, is more substantial than for those who invest in equities alone.1
2. Lack of correlation to traditional assets
In recent years, some private market assets have performed in a way that does not directly correlate with the performance of equities or bonds. In an investment portfolio that aims to perform well in several different economic scenarios, they could be a useful component.
Take music royalties for example. The performance of these assets is uncorrelated with that of the stock market. They could constitute a valuable part of a DC portfolio.
3. Protection from inflation
With inflation predicted to remain higher for longer, investors are looking for protection. The long-term, buy-and-hold nature of many private market investments, as well as their ability to absorb or pass on cost increases means that, to an extent, these strategies can provide investors protection against inflation, both from a mark-to-market and fundamental perspective.
Pension regulators highlight private markets opportunity.
The government noticed that private markets may have potential in aiding portfolio balance for pension schemes.
In January, The Pensions Regulator (TPR) released guidance on private markets, acknowledging that such investments “can play a valuable part in a diversified portfolio that aims to improve and protect saver benefits”.
Pensions Minister, Paul Maynard, and The Pension Regulator’s Louise Davey are backing the inclusion of these assets in more funds, so momentum is likely to continue, leading to better fiduciary management around private markets and increased interest from scheme members.2
For trustees, with perceptions shifting further in favour of these assets, now is the time to seek advice on whether they are suitable for portfolios – and how best to use them.
Private markets could help DC schemes meet sustainability goals.
Most DC schemes need to hit sustainability goals and private markets could help them.
Investors can participate in the climate transition with infrastructure funds. They can take a seat on the board of companies they invest in through private equity or, when providing private credit, include sustainability criteria in loan agreements.
With the sense of urgency around climate change expected to increase in coming years, sustainable investment choices such as those in the private markets space could become more popular with investors wanting to hit these targets, which could in turn have a knock-on effect on performance.
What are the challenges for investors?
Private market investing is an attractive option for DC schemes, but many face challenges as they invest.
One of the biggest is liquidity risk – unlike assets that can be traded on the stock markets, private market assets are tricky to dispose of. Schemes that decide to invest in private markets must have a defined strategy on how to liquidate assets in times of market stress and undertake testing on their portfolios to ensure demands for cash can always be met.
Sourcing assets can be tricky, too. Investors may struggle to acquire assets at the right price, risk point, and quantity. For this reason, private markets should only comprise part of a diversified portfolio.
In general, adoption is limited and there isn't always the infrastructure in place for smaller schemes to acquire such assets in the first place – 73% of DB schemes in the UK have less than 100 million AUM.3 Schemes may therefore require support with accessing assets.
Valuation is a challenge for all assets contained within DC schemes and private markets are no exception. Members moving in and out need some comfort that robust pricing is in place.
Schemes can mitigate many of these issues by seeking appropriate investment advice on the correct way to implement their strategies to ensure they are tailored to member needs.
It is important to ensure appropriate governance is in place and that all regulations are met in terms of policies on illiquid assets.
A bright future for private markets
While private markets are a relatively new asset class for many DC schemes, they provide a possible solution to current concerns. As these assets become more popular with those seeking diverse investments that can help meet sustainability targets, they may outperform further.
For those DC schemes which can negotiate the challenges posed by liquidity risk and an often-bewildering choice of assets, private markets may be worth a look as they seek to balance risks and opportunities in a changing world.
This article is a summary of BlackRock’s Private Markets PensionShip podcast, featuring Simona Paravani-Mellinghoff, Global CIO of Multi-Asset Strategies and Solutions at BlackRock and Brendan Walshe, Investment Consultant at The Pensions Regulator. You can listen to the full recording and the rest of the series here.
1 Bloomberg, Barclays (Investment grade: US Agg Bond; Gov’t bonds: US Gov’t Agg TR), NCREIF, MSCI (Global Real Estate); EDHEC (Infrastructure: All equity) and S&P (Stocks: S&P 500); as of 22 May 2023 (annual data since 2001).
2 The Pensions Regulator, New TPR guidance on private market investments helps trustees boost saver outcomes, 24 January 2024. https://www.thepensionsregulator.gov.uk/en/media-hub/press-releases/2024-press-releases/new-tpr-guidance-on-private-market-investments-helps-trustees-boost-saver-outcomes.
3 Pension Protection Fund, PPF Purple Book for 2023, 31 March 2023.
