I’m booked to deliver a “keynote fireside chat” later in the month at the European Private Markets Summit in the former Georgian residence of Lord Mountbatten near St Albans.
The full 2 day agenda is here , I’ve been asked to give an update on the private market sector and its impact on pensions, trustees and their feelings towards the sector.
The fireside chat is taking place incongruously at 9.30 am on Thursday 24th of this month. It’s got me thinking. I’ll be speaking shortly after returning from Liverpool where I am reporting on the PLSA annual conference which should give me some soundings, nonetheless, it is interesting to understand what has changed since I last did one of these things , a couple of years ago near a field in Hampshire.
I have four immediate thoughts
- There is nothing “fireside chatty” about this. The pensions industry does not regard the redirection of assets shored against the financial futures of its customers, as a cosy deal between friends.
- The terms of engagement between the private markets and the pension buy-side are changing and changing in favor or the buyers
- The pressure on pensions to absorb private assets into its portfolios has massively increased. With the responsibility to deliver on Mansion House and Labour’s recent policy statements , pension funds are demanding to be taken seriously by the secondary banking sector,
- Because of recent experience -private markets are asset classes the pension industry by and large distrusts.
The fireside brings back recent memories of the “fire-sale” of illiquid assets that happened to meet collateral calls following the LDI crisis. The haircuts that trustee’s took on these assets meant that years of deficit contributions were wiped in a few days. The impact on employers of losing real assets which they had paid for, to pay for what many saw as imaginary protection of their balance sheet has not been forgotten by trustees or sponsors.
We have yet to properly measure the impact of the loss to the asset base . Con Keating and Iain Clacher’s analysis of ONS v TPR/PPF estimates suggests that DB pensions lost in total around £166 bn from pension schemes.
But so long as the estimates vary as they do, Regulators can immunise themselves from the overall scale of the disaster. .
It is important that this does not happen , not least so Government is properly aware that investment in illiquid private market assets carries liquidity risks it may not foresee.
Just as the pensions industry must learn lessons about the means it protects itself from the volatility of its liabilities, so it must better understand and manage the liquidity of its asset base. The private markets have a lot to do to provide evidence that there are secondary markets, that valuations are fair and that the cost of participation in the ownership of these assets is evenly distributed between all owners.
The development of LTAFs should go some way to enable smaller DB schemes to access private markets in a way that provides such protection, but I worry that the price of the LTAF will be more than the cost of wrapper, the pensions industry must not sacrifice the opportunity to benefit from the IRRs the private markets have and continue to enjoy, for the sake of a wrapper.
Lifting of the double disclosure requirements on investment trusts makes them a more readily accessible vehicle – especially for the wealth end of the pensions spectrum . But pension schemes need more than LTAFs and Investment Trusts , they need the confidence of those who manage them and provide fiduciary services to their beneficiaries.
What is needed is a full-on educational campaign through the Investment Association , the BVCA and other trade bodies that explains private markets to trustees without the need of expensive intermediation.
We are beginning to see trustees, through their marketing organisations, get much closer to the management of the funds and indeed the assets. It helps that these marketing organisations are themselves owned by private equity.
But so long as trustees see the management of private assets as “dark arts”, suspicion will be that investment is required rather than desired. If trustees own private markets as an obligation then the investment will not be sustainable. Private Market investors need to understand why they are investing to remain committed to those investments.
Patient Capital cannot be patient if it is under constant threat of liquidation. The point of private markets is that they deliver if held.
And herein is the biggest issue for pension schemes. With the end-game upon them, how many trustees are prepared to back themselves to hold their assets over time. I say this for DB trustees, but until we get a long-term view of pensions in DC – the same can be said for its end-game.
I wonder what size of pension scheme can invest in private markets outside of a pooled fund arrangement. Even the large Canadian pension funds investing in UK assets do so through multiple pooled funds (both evergreen and closed end to my knowledge and possibly ETFs). The pension scheme is therefore effectively choosing the investment manager rather than the underlying investments – in many cases the manager will be incentivised by performance related rewards, based on their valuation of the underlying assets. The managers are therefore encouraged to invest in underlying assets that offer the greatest short-term prospects, either in interest or dividend payments or the prospect of an early IPO.
The whole life pension scheme and the Government should be interested in investments that may not provide particularly strong early prospects but will support the pension scheme with income or redemption proceeds in 20 or 30 years time from this part of its portfolio.
Sadly, my own experience of PE is by now very historic.
Stagecoach Group Pension Scheme began investing in private equity in the 1990s after witnessing the quadrupled capital return plus special dividends (including 8% preference shares) which seven Scottish private equity firms had enjoyed by investing in Stagecoach’s 1988 private placing through to the company’s LSE IPO in 1993.
We chose for the pension scheme to be limited partners alongside general
partners who co-invested significant amounts of their own capital, by which I mean 10-20% of total fund, not 1-5%.
We also took comfort in some of the parent relationships – eg Montagu was initially 75% owned by HSBC, SL Capital was majority owned by Standard Life.
Unfortunately over the years the PE managers tended to buy themselves out of parent relationships, majority ownerships falling to 20% or less. And as funds raised became larger and larger the levels of co-investment by the managers themselves fell to those trivial levels of 1-5%.
Closing the DB scheme to new members by 2010 (by which time the scheme was also nearing 25 years’ old, which meant pensions in payment were rising) caused us to make no further new commitments to PE.
At our peak we committed at least 25% of scheme assets to PE in order to have 10-15% “in the ground” as funds were cautious in their investing, taking at least 5 years to fully deploy capital raised.
Yes, the DB scheme enjoyed double digit returns on average from 1998-2008, but subsequent returns were lower, high single digits only, and nothing like the quadrupling of capital we’d seen in the early 1990s.
I also had a gnawing suspicion, borne out by some analysis our scheme accountant did for me after the 2010 decision, that our net cash flow from PE was negative. This was because while cash was returned from the earliest partnerships, the subsequent partnerships became larger and larger and in order to maintain our levels of commitments we had to invest more than we had received back.
I later became familiar with the academic research on PE by Ludovic Phalippou and my misgivings were further confirmed.