I’ve had an intriguing question from a friend, perhaps prompted by my recently published submission.
What proportion of PSH assets would be in Private Equity or infrastructure? To what extent would the latter vary at different amounts of AUM?
Private equity can of course invest in infrastructure but I think the question is really about the duration of tenure. If we assume private equity has short term time horizons and is about deals and infrastructure sits around for decades- even centuries then the question is about intention and duration.
Coincidental to the asking of this question, we had a presentation at Pension PlayPen about the creation by one pension consultancy of an exchange for illiquid pension assets so that trustees could get liquidity from long term investments. It strikes me that if you need to generate liquidity from long term assets then you are closer to a hedge fund than a pension fund.
Specifically, the question seems to be whether with size, a pension fund can afford to take longer views than a pension scheme without size. So for instance USS can afford to take a long-term view of its infrastructure investments despite the hiccup of Thames Water, because it has the size to do so. I am not sure that this is quite right. If Thames Water shares were held by a private equity fund (rather than directly), then the fund could afford to take the bath, but if a small pension scheme put everything on red (Thames Water) and lost, it would be in the PPF.
My point is that the Assets Under Management (AUM) of USS allow it to construct its own portfolio of private assets , rather than pool with others and that is what makes it and Nest and other direct investors – different, they look to improve VFM for members by doing it themselves, researching their own opportunities, executing their own deals and exercising direct control over the asset. Thames Water is an example where all this goes wrong but it does not disprove the theory that with scale comes value.
But what makes USS different from many other pension schemes, is that it has no end-game. It is a collective scheme with an infinite time horizon. So long as there are places of higher education and staff to be pensioned, the USS could and should continue to provide pensions. See Derek Benstead’s diagram below.
If the intention of a pension scheme is to stay open, it can afford to invest for the long-term – infrastructure over private equity. If it has a short-term horizon, because ownership of the pensions is likely to change to an insurer or the PPF, or because the tail of residual liabilities is short, then the scheme should be thinking about matching liabilities to assets and if private assets are deployed, they should be short duration private credit.
The difference in outlook can be well explained by the tale of two consolidators. Clara is a consolidator with a short term horizon, making it clear it is a bridge to buy-out. Consequently it needs to consider itself a private equity proposition with asset allocation focussed on the kind of horizons of Private Equity exits (5-10 years). Pension Superfund had no such end-game, it’s model was to run on till the final liability was met.
Pension Superfund did not intend to consolidate schemes that were actively accruing so it had a finite timescale, the payment to the last surviving pensioner. This is still an endgame but an endgame distant enough for it to be investing for long-term rather than short term gain. Infrastructure rather than private equity if you like.
Pension SuperHaven is a longer term pension still since it is looking to take on new liabilities as they come due. Coming due in this sense means when people choose to swap DC pot for DB pension. I can see no end in sight for the need to convert DC pots to DB pensions.
So PSH looks more like USS than even Pension Superfund and certainly a lot more like USS than Clara.
USS and PSH should share the same fundamental characteristic, to pay pensions when they come due over a long time horizon. The capacity of both schemes to invest in long-term assets is down to the covenant. USS is backed by Britain’s universities, PSH is backed by capital from the Truell foundation and from investment banks.
The amount that PSH can invest into infrastructure as a mature pension (the majority of its customers will be wanting immediate pensions) means that it will be constrained by the Pension Regulator’s DB funding code and the scheme itself will be invested conservatively (mainly in bonds). As she scheme gets bigger, so the investments will be more efficient (moving towards the direct investment model which large schemes can employ). Value for Money will improve with scale – here are the economies of scale.
The only way that the PSH scheme can more more into infrastructure and be less reliant on short term investment considerations is if the DB funding code relaxes further and guidance to capital backed pensions eases to allow more of both the scheme and the capital buffer which is the “sponsor” can be invested in long term assets such as infrastructure.
This easement is in the Government’s hands. It must recognise that in relaxing funding rules , it is dialling up risk within schemes such as PSH, risk that the scheme might over-reach and go into the PPF, risk that would be spread over a wide constituency of PPF levy payers.
But this is at least a risk that Government can take (the PPF does have a £12bn surplus) and it may be more acceptable to take risk this way than by mandating that DC schemes should take the risks of taking long term investment bets when they have an endgame based on the investment pathways.
The answer to the question is that asset allocation is down to the Regulator while VFM is down to size. Right now the argument is all about consolidation to create size but perhaps it should be extended to risk. Should pension schemes be able to take more risk when they have longer term horizons? Of course they should. Can they – not yet, though the DB funding code is gradually easing.