This blog is about the continuing relevance of asset and fund managers against the rising tide of Exchange Trading which is making their business look increasingly anachronistic.
Since the bulk of assets in the pension funds we invest in are selected by computer and often not selected at all but owned as a derivative of the asset itself, the cost of fund management is now too low for it to be considered by pension schemes competing against each other on price.
However, the particular problems that fund managers can address cannot be dealt with easily by ETFs. In particular the fund management industry has found a new role for itself as the stewards of people’s money , managed under ESG principles and the creators of value in society through the introduction of social impact and purpose. These moral aspects to investment still require people to make decisions and deliver value.
Yesterday the DCIF delivered a small but valuable paper , suggesting that the activities of active fund management may be gaining traction , albeit in a small part of a much wider market
But first a bit of context; the DCIF is an affiliation of fund and asset managers which produces reports on the state of the defined contribution pension market in the UK. As such, it is pretty niche. But it is self-funded and shares its research more generally, typically through seminars which I can attend, not least because JP Morgan’s grand hall is within walking distance of where I live.
I had just read Arun Muralidhar’s excellent article on why pension schemes should not be rushing to private markets, so this article may sound a little negative. To be clear, I do not agree with Arun, but I think that his arguments are fundamental and weren’t addressed yesterday. The barriers to investing in private markets are firmly entrenched and in the heads of the general public, we don’t understand why we should!
What is the value of private markets that it needs to break down barriers?
My major problem with the paper that the DCIF has produced , is that it does not properly explain why savers in DC markets should want to have private market investment in their investment strategies. I don’t think the case for getting bigger pots from private markets has been properly made and this report is another missed opportunity.
Mark Austin in his foreword argues that the needs of DC savers have largely been ignored
Accessing private markets will give pension scheme savers exposure to a more diversified opportunity set, potentially helping to cushion them from the ups and downs of the
global economy, as well as giving them a wider range of reliable sources of income.
But it is a stretch to suppose that DC savers are looking to be cushioned or looking for a wider range of reliable sources of income. We are looking for one thing from DC saving – bigger pots. Since DC savings plans have yet to offer conversion to DC spending plans, the only thing that fund managers can aspire to is giving us savers bigger pots.
But the fund managers are still using the language and concept of DB plans, an example of which is the paragraph in italics above. Until it can be demonstrated that investing in more expensive assets leads to bigger pots, the argument has yet to be made. Diversification is not an argument that savers properly understand, returns on savings (aka performance) is something that we can understand.
The chart below suggests that trustees and funders of large DC schemes get this.
The obsession with “risk adjustment” is a barrier!
You’ll note that the choices offered did not include “absolute returns” but instead “risk adjusted returns”.
My first frustration with DCIF research is that it makes a weak case for private market investments. The big problems that listed companies find it hard to address but which the private markets address well, are tangible and recognised. For instance we learned yesterday that £60bn is needed to wire up offshore wind farms and other forms of energy to the national grid. Where is the money coming from for the cables to do this? The answer is from the private markets (I happen to know one company competing to deliver).
The delivery of a £60bn project needs lots of capital, something that pension schemes have. I hate to sound flippant, but £60bn is a drop in the ocean for funded pension schemes in the UK, it is a major headache for the National Grid.
The lack of supply and the immediate demand for cables, presents pension schemes with the opportunity to do something useful and get well rewarded for it. This takes the imagination and nerve associated with the private equity market. It is not a strategy that is likely to feature in the world of ETFs.
The first and most important barrier for private markets is that no one is making the case for the absolute return, everything is couched in the slippery language of risk-adjustment, or non-correlated assets and of diversification. Private markets have to have a better story to tell, who is telling it?
My second frustration is with the technicalities of delivery
Without clarity on “why”, we are left to ponder this report which tells us that private markets are already getting a wad of our cash (illiquids = private markets).
I am a little suspicious of this research as only 21 pension schemes participated and they were unusual both in size (big) and in wanting to talk about these things.
A key observation of the report is that until you are of a certain size, you cannot think about these things for yourself.
Corporate DC schemes is a scheme run by a company for its staff using its own resources rather than sharing in a commercially resourced structure where the costs are spread among many employers.
The need for advisers becomes clear when you consider the demands being placed upon trustees as to what they might consider as private market investments.
There’s a lot to research and to evaluate. This complex market is itself a barrier . The question is whether there is either the research budget in-house of a consultancy budget to get these complex decisions right.
Faced with the uncertainty of whether investing would give people bigger pots and the barriers of complexity, the question of how to pay, is leaving most decision makers bamboozled. The key stat here is not about the committed “yes” and “no” but about the nearly two thirds who haven’t got a firm view.
This lack of cohesion among the 21 schemes that participated in this survey is worrying. We have been going over this ground for 10 years now. We have had many consultations but we still don’t have consensus.
There is more consensus about the wrapper for the private assets to be invested in
The LTAF is the chosen vehicle of the funds industry and the investment company is the traditional way that pension schemes get access to private equity (the principal asset class required). That investment companies were not on the list of choices is strange.
The researcher asked the audience how many LTAFs were in the market and no-one seemed to knew, we were told that there might be as many as 10 but the vagueness around the number suggests that two thirds of the schemes are heading towards an unformed market.
I would suggest that a major barrier to entry for many schemes is the lack of understanding of LTAFs, what they are doing and the pros and cons of LTAFs compared to less intermediated alternatives.
I’m also baffled by the importance placed on “co-investment” rather than direct investment. As I understand it, “co-investment” is a toe-dipping exercise where a pension scheme follows a private equity fund into an asset. It would seen that even with the increasing size of DC schemes, the amount of schemes that will directly invest is vanishingly small. This suggests that there remains a big barrier of confidence in investing into the big projects directly. This lack of confidence is not mirrored elsewhere, many DB funds are directly investing. DC has a lot of catching up to do
The courage of its conviction
I read yesterday
Calpers – the biggest public pension plan in the US, is to invest more than $30bn in private markets https://t.co/a17yv2qtgE via @ft
— Josephine Cumbo (@JosephineCumbo) March 19, 2024
For all the knowledge in the room yesterday, I did not see much courage or conviction.