I’m a big fan of investing in developing businesses. In fact, I use a platform to help me identify new and exciting businesses to invest in. Some might say that my exposure to the drinks sector is larger than it should be within my overall portfolio, but the side benefits are often significant there too!! I’ve also invested in a premium snacks business and a company which produces an alternative to plastic. It’s an exciting thing to do and I feel personally interested in the companies that I’m helping to develop. Many of the opportunities that are available now focus on technology and sustainability and are companies which are seeking to disrupt; this can only help to raise the bar for all.
Currently, there are two big topics of conversation going on in the world of DC investing – ESG and illiquids. There are pressing reasons for DC schemes to know more about each of these and I’d argue that any DC trustees or governance committees which have not started to consider the impact of ESG, and in particular climate change, are behind the curve.
The topic of illiquids is an interesting one. We need to be careful that the reason we consider investing in illiquids is not because we’re encouraged to do so by the government or the regulatory bodies, or that we’ll feel “left behind” if we don’t. FOMO does not always lead to the best outcomes! Any decision to invest in illiquid assets should, in my view, be driven by our primary purpose – which is to deliver better outcomes for our DC members.
When we think about it, for many years, DC schemes have already been invested in illiquid assets by way of direct property holdings. In some cases, these have added value. In others, they have not. I believe that the consideration of the potential use of illiquids in DC schemes should be driven by two questions:-
1) Will they add value for my members, net of all fees, over and above the current investment assets used? and;
2) Will they give me exposure to something I can’t access through liquid markets?
Only after getting a positive response to these questions do I believe we should be taking the discussions further. There will inevitably be further hurdles to negotiate in terms of aspects such as charging structures, liquidity, fund pricing and ESG credentials (including reporting). But if we can find the holy grail – better and more sustainable long term returns for our members – we should take the opportunity to examine the options further and invest if appropriate.
One area which is rife for consideration is that of private markets, and particularly private equity. In the US, history tells us that companies used to take around 3 years to come to the public market - this number is now around 9 years. And there’s also evidence that many companies are bucking the historic trend and moving back into private ownership.
Private companies currently make up around 10% of the global market. And in some areas, this is even more pronounced. For example, in the US there are 2,300 active private equity firms investing into over 110,000 private companies, an opportunity set much larger than the number of publicly traded companies (3,600+). Many of the benefits of diversification could be lost by investing solely in public markets.
So, taking an approach that purely focuses on publicly quoted companies will exclude a meaningful part of the global opportunity set. That, to me, is a viable reason for considering investment outside conventional markets.
And there are other areas which could merit consideration. Green infrastructure and clean energy projects may not yet be available through traditional pooled vehicles but can help DC pension schemes not only diversify their risks but also benefit from long term, sustainable returns. Good news stories, and in particular local ones, of successful infrastructure projects, for example, could also potentially help to engage DC members in their own pension savings.
We shouldn’t forget that many pension schemes in the UK already have access to “alternative” markets through quoted vehicles (for example Real Estate Investment Trusts). Over the short term, these may see higher degrees of volatility than the underlying asset classes but ultimately, they should, over the long term, broadly reflect the returns of the direct investments. These types of solutions should also be put on the table for further examination.
So having said all this, do I believe that DC schemes should be considering investing in illiquid assets? Yes I do. But we should always go back to answer my two initial questions and be able to have clear “yes” answers to them before we proceed.