Private markets: what is the opportunity for the UK pensions industry?

Transcript

Louise Doherty: Hello and welcome to the Thinking Forward podcast with myself, Louise Doherty, and Mike Ambery, where we explore the trends and developments affecting the UK pension industry.

We're both really excited today to have first time guest Michela from Phoenix Asset Management.

Michela, really warm welcome. How are you doing today?

Michela Bariletti: Very well, thank you. So nice for you to have me today at the podcast.

Louise Doherty: Looking forward to it. Fabulous. Why don't we start by just, why don't you tell our listeners a bit about what you do for us at Phoenix Asset Management?

Michela Bariletti: Sounds good. So I work in Phoenix Asset Management, and my title is Chief Credit Officer and also Head of Investment Research. So what I do and what my team does is basically looking after credit risk that is on our balance sheet, as well as providing research for supporting all our investment strategy across macro sustainability and credit, supporting both our defined benefit pension schemes as well as our defined contribution pension schemes.

Louise Doherty: So it's not much then, we're keeping you busy!

Today, we're so pleased that you've joined us. We are going to be exploring the world of private markets. So take my knowledge to be nothing, so we'll start there, so this is going to be a bit of a tutorial for everyone.

So first question is can you give us a 101, tell us a little bit about private markets and why we should be interested.

Michela Bariletti: So basically the definition of private market is it really sits in what we just said. It's private in nature, meaning that it's not available on a public listed type of exchange. It's private, so tends to be done in a private setting. So the opportunities to invest are not listed anywhere. And therefore is some challenges linked to it because they are, this type of private asset are tend to be not that liquid. Tend to be you're not able to basically price it on a regular basis, and tend to need a lot more due diligence and expertise in order to understand the risk attached to investing in private assets.

But to give you an example and make it more real, example of private assets are private equity. So you basically invest in companies that are not listed on a stock exchange. And more often than not, the way that you get out of a private equity is actually by listing it once it gets to the maturity that it can actually be listed publicly.

But also, private asset and private market have been, we got to know them a lot more these days because of their, their opportunities for providing infrastructure, real estate, but also on private credit. So just to give you an example, in the sense that some of the infrastructure that you use every day, are actually funded by private market rather than public listed market

Louise Doherty: What type of investment then would that be?

Michela Bariletti: It could be like a solar farm or your offshore wind park. So sometimes there are infrastructure that are a single project. They may not have the size to be funded on the public listed side, or they might require the expertise to be able to manage the assets during the operation of this asset. So some of the assets needs the, are better managed through private because you need more interaction with your borrower or with the project that you are funded compared to a public listed asset where, you know, it's more, you know, the information are public, the documentation supporting this type of assets or supporting this type of investment are quite standardized.

While in the private you tend to have a bit more of a bespoke nature, so you can accommodate both your need as an investor as well as the needs of a borrower, depending on the situation that you are trying to solve for or support.

Louise Doherty: Okay, and thinking our listeners generally work within DC pensions. So what is the relationship, I suppose, between private markets and DC?

Michela Bariletti: So it's interesting you asked this question because in the UK, that is not much of a relationship really, in the sense that the historical allocation of defined contribution pension scheme in the UK to private asset has been fairly limited for various reasons that we may want to explore.

While if you look at, our international peers across Canada and in Australia, the allocation of pension money, not just DC schemes but just pension money in general to private asset, or alternative, has been quite a lot higher.

Louise Doherty: Okay. Mike, so quickly come to you. Actually, you've spent some time in Australia last year, and a few of our guests have talked about the use of private markets within pensions. Any points that you want to add?

Mike Ambery: So I completely agree with what Michela said. I mean, Australia is, probably more of a mature market in terms of this investment area. As you break down the Australian investment, it's heavily in domestic equities but equally heavily in a growth phase on private markets and private assets.

And those can be within the UK investment by Australian superannuation funds. It's the same as true with Canada. I'd also go as far as to say within UK, DC is more for the point of liquidity and transparency, that's where DC has come in more recently, as opposed to, within DB, it has existed for some time because you don't need to have the data dealing in liquidity available on those funds.

But to answer basically your question on Australia, private assets do form for some of the larger mega funds out there, around 40, 45% of their sort of asset allocation, compared to which I'm sure Michela will come on to, Mansion House and, maybe the quota, available to that.

Louise Doherty: So I suppose what I'm hearing is, I was going to ask if it's a new thing, because what we're hearing so much about it now, but actually it's been used in DB historically and now is starting to migrate over to DC. Is that?

Mike Ambery: Yeah, that's absolutely right. I don't want to steal Michela's brains or thunder, but how does that transparency, how's that liquidity come through? Where all the talk about LTAFs and explain what an LTAF is in a minute or two. And so, that was sort of introduced in 2021 and by the FCA. That regulation enables that transparency, daily dealing.

Somebody in a DC fund wants to know what their price of their pot is instantly. And I, you know, I look at an app and want to know how much my pot is worth at this point in time. 
I don't want to wait for X days to be able to work out. In a DB, I just care what my level of benefit is. I don't need to know daily dealing because I know my level of benefit.
So there's differences there as Michela more than adequately defined earlier.

Michela Bariletti: But on your new point, there is nothing really new new here in the sense that if you think about private equity, probably the first form of private equity dates back to the end, you know, at the end of the Second World War.

What probably became a bit made, a bit more the headlines is this booming in private credit, in the sense that if you look at private credit growth over the past 15 years has been phenomenal, to the point where you may have read headlines about the golden age of private credit. And, so, if you look at the market as of at the end of 2023, we were talking about $2 trillion in private credit and is ten times bigger than it was in 2009.

And this is, it's good that we pause a second because 2009, you're basically at the back end of the global financial crisis. Therefore, the growth in private credit was really driven by, first of all, bank needed to derisking a bit their balance sheet or in any case, restructuring the balance sheet due to the additional requirement on the back of the global financial crisis, as well as the appetite for investor to finding yield, because we have experience years of very low, very low interest rate.

So the growth has been quite phenomenal.

Mike Ambery: Michela, if we go into probably a couple of questions we've touched on already, what's the delay in using private pensions in DC?

Michela Bariletti: So I think you touched upon that, clearly, before, so first and foremost, I think is, fees in the sense that there's, my understanding is that from a regulatory perspective, there was a capped charge, a cap on the charges. And, there is also a certain pressure to keep the fees as low as possible to ensure that customers have access to product, but at a reasonable price. Unfortunately, illiquid assets are more complex. Private assets are more complex. So they tend to require higher fees to manage it, but also because you need a different skill set, to underwrite the risk of private asset.

Also, there's a question about, as you pointed out, about the fact that you don't have daily valuation so the valuation can be stale. So that raise a question about performance fees. And how you potentially do calculate performance fees in a very fair and consistent way.

And finally it's a question of operation. You said it, you mentioned it yourself, that customer today are used and have an ability to access their basically their DC pension pot on a daily basis with daily prices. That wouldn't be really, really happening when you have a private, a private asset.

And finally, probably a bit about governance and about also having trustees be wary of this type of assets and kind of getting familiar with the risk, profile of this type of asset.

Mike Ambery: Nice. Really cool.

Just a little bit of an outtake for me will be we do race for the bottom for pricing, which has been a movement in the industry for quite a period of time. You raise a point about cap levels, sort of charge structures, and otherwise, I think we as trustees, fiduciary and sponsoring employers, we've tried to move away from that and we've started to move towards outcomes.
You know, you can pay more to get more. And we should be considerate of what those outcomes and what that modelling looks like. And that's what I see as the evolution.

So I guess with Mansion House and signing up for Mansion House compact and then Mansion House 2.0, I guess the next one would be 3.0, unless there's an iteration in between. We won't debate that one, but I guess the question is why aren't people, by people, I mean schemes, trustees, on behalf of their customers, why aren't they like, piling in on this? Why was there not this big land shift into private assets right now?

Michela Bariletti: I think, you know, private asset, first of all, I don't know why, per se, in the sense that, to me is it feels sometimes when you think about what our Australian peers and Canadian peers were able to do with the pension money, meaning being able to invest in your own country to support that infrastructure, to me is a win-win for the customer as well as for the government. In the sense that you're basically using your pension pot to get a return on your investment that actually, on average, has been way higher than the return for our UK pensioner. And on top of it, you find yourself living in a place with better infrastructure. So there is a sort of a win-win.

I think what remains, the obstacle sometimes is really the private nature of these assets and the potential perception that it's a bit opaque and that the information are not readily available, and therefore you need to ensure that you choose the right, the right manager and the right counterparty that has the appropriate governance internally and the appropriate skills and capabilities to understand the risk that it takes in order to basically onboard this type of asset. And manage kind of the right risk return according to the appetite of your customer as well.
Mike Ambery: Which is a perfect answer for, you know, yourself looking at risk and how we manage portfolios. Exactly how I'd want to be. And then equally on outcomes, that's really we manage risk based upon outcomes.

If we look at Australia, that 40, 45% is generating higher performance, comparable to, say, the UK model. So it makes sense to invest in the right structure and sort of classes there.
If we actually unpick some of the terms then, what the heck is a private asset and how do we invest in in a DC. We could do private credit, private debt and all of that. But I said a term a minute, an acronym a minute or two ago - an LTAF. Other than it being connected with tennis, if you Google it, what is an LTAF?

Michela Bariletti: So it's a long term asset fund. And this was, this is a regulated product. As you mentioned. The FCA launched it in 2021 to provide basically DC customers the access to private asset. And I think what is good about the launching of this product is that it's regulated. So I think gives comfort to the customer about the regulatory nature of the product. Provide you access to private, and by private is private asset, meaning productive assets. So not just private equity, can be venture capital, it can be private credit. So it gives you a range of, the possibility to have exposure to a range of assets. It's an open-ended structure that basically enables you as a customer to potentially sell and buy units.

So depending on your journey to and through retirement, you can basically accumulate or decumulate your exposure, your exposure to this, to this product, meaning that it kind of helps you to, helps you addressing the issue of liquidity.

And therefore it could be a really potential good opportunity for the customer to access, to access this type of, this type of, you know, sector.

Mike Ambery: So if I call it right then, with LTAFs, it's like my milkshakes. It has different contents in it, if, if you'll allow me to say that. Some have good levels of liquidity, i.e. good product in the milkshake, and you have others where there's different levels of liquidity, different types of assets within that structure itself.

So, there's a probably quite a lot of LTAFs that are available on the market. And, and is it, sort of consumer beware of which one is better for themselves?

Michela Bariletti: But I think it depends on your risk profile, really. I think a customer needs to ensure that they understand what they are investing in. I think it's important that you understand the risk profile that you sign off, that you sign off. And also ensuring that the product is right for you and for where you are in this journey.

I go back to the point of the journey in the sense that illiquid asset tends to be, you know, tend to provide better return, but on a very, on a much longer term as well. So it's also a question of what is your time horizon in terms of the investments. And I think that's why, thinking about the LTAF, and thinking about the unit of the LTAF, means that allows you to give you this flexibility to potentially accumulate, decumulate, depending on where you are. That could be quite that could be quite helpful.

But the reality is that private assets wouldn't be good for everyone. I think is still depends where you where you are. Probably if you are towards the end of your journey in terms of the accumulation, and you have a shorter time horizon in terms of investment because you want to access your pension pot, that might not be the best product for you. Well, if you are at the beginning of the journey probably being overweight on private or looking at private more interestingly, because you have a long term to basically look through to that, to the lifespan of the investment, could be more interesting. So, I think it really depends. I don't think one size fits all.

Mike Ambery: That makes total sense. So if I'm an individual employee or an individual in the UK with access to DC market, where will I get private markets from?

Michela Bariletti: In what sense? So in depth, from your workflow pension scheme I guess so from your workflow pension scheme provider.

Mike Ambery: Okay

Michela Bariletti: And that should be part. So what we are, what the industry is trying to do is basically that in your in your list of options, in terms of product that you can choose from, you will have access to private market. And potentially the reason why you want to have multiple products in, in your, in your choices on how to allocate your pension, is to ensure that you maximize diversification. Because I think one of the reasons to ensure that the customers are going to have access to private market is for diversification.
So instead of being stuck, let's say with private, public listed equity and public listing fixed income, you can access a different asset class. That should help you diversify the risk profile of your allocation. Also, because it gives you access to assets that are not readily available on the public market.

It's for the pick-up in the sense that relative value, from a relative value perspective, the history would tell you that private assets will perform better on the long term. Again, we shouldn't forget about the time horizon. It can match your long-term perspective in the sense that again, if you are in your accumulation period and young in your journey, they provide you long term prospect because they are longer term in nature.

They tend to provide you structural benefit in the sense that the person who is managing it for you can engage with the borrower so they can provide like better, sometimes better protection in a downturn.

So and also gives you access to sustainable assets in the sense that one of the, one of the opportunity really when you look at a liquid investment of private market is really having access to potential, the development of new technology to support the sustainability, the net zero transition, that can give you access again to project infrastructure. Whether these are for you know, clean energy or for battery storage? Data center.

So and I think ultimately what the industry is trying to do is, is give the customer or the employee that you're mentioning, the option to choose to allocate their money to these type of assets.

Mike Ambery: And that makes total sense for me as an individual, I probably won't get to that level of education very quickly, but I can take it probably through a default, through either my master trust or my contract based scheme, or recalling my employer's trust scheme. But knowing it's there, being able to deliver that greater level of outcome is probably useful.
Which brings me onto a question of so what we've learned from Australia and the US, and Canada, heavily invested in private markets, does deliver outperformance. Do we expect the same in the UK?

Michela Bariletti: We would expect so! In the sense that ultimately, whatever you do or whatever commitment you make, call it the Mansion House compact for because we are talking about the Mansion House compact, you do it to, you do it as long as it makes sense for your customer.

So the reality is that I think, I think the access to private market and the ability for, for the professional to invest some of the pension money into private asset as well as for the customer to choose this type of, this type of asset, would also support the growth agenda of the UK government.

So I think, as I said before, I don't want to repeat myself, but it sounds a bit of a win-win, right? So you want to push growth in the UK market. And it would be great that the upside of certain investments proposition and certain opportunity, comes back to UK customers, rather than to Canadian and Australian pension funds that, of course, you like a diversified pool of investors. So you would like the UK to remain a destination for investment, not just domestically but also globally.

But at the same time you would like to be able to participate at the same level as your Australian and Canadian peers who, by the way, are already investing in the UK infrastructure.

Mike Ambery: 100%. And that makes total sense to me in terms of why invest in private markets? What's in it for the UK government in terms of economic growth and boosting? Equally, saying that's a win-win for consumers. If we get a greater economy, we get greater outcomes, greater returns and a greater, state of living, which is all good in theory.

I know there's lots of questions and we won't debate whether the government should mandate this. I think it's a direction. It's a point if the industry voluntarily can go to this, and I guess we will, sort of converge on an area where we will have private asset investment because it does improve outcomes in the right areas with the right research. Cool!

I think that's down to Lou, you've always got a crystal ball available.

Louise Doherty: It's a crystal ball. It sounds like you've already answered it though, you know.

Okay, I'm always going to have to do this, aren't we? If you had a crystal ball, fast forward ten years, what does it look like from a private asset? So are we going to look like Canada, are we going to look like Australia?

Michela Bariletti: So I think, so hopefully in ten years, the UK DC pension provider and customer will be able to allocate more to private asset. Again when it makes sense for the customer. Also I think ultimately given where the UK is today and the level of that, they need private participation, public private partnership, I know it's a word that many people would like, oh the private public partnership, but if that if it's done well, I think it provides growth for both them, for both the pensioner as well as the government.

So I think in ten years time, hopefully we have better infrastructure. UK is productive again and we are in a growth path.

Louise Doherty: I hope that the crystal ball prediction is correct then, that sounds like a win-win all round.

Thank you very much everyone for joining us today.

As always, if you want to catch up with previous podcasts or articles, just search Standard Life Thinking Forward online and also get in touch. If you've got ideas for future episodes, or if you'd like to come and join us in the studio and share some of your own insights. Thanks.