By years end retirement savers in U.S. and U.K.
defined contribution schemes could be investing in leveraged
buyouts and distressed-debt deals. In a big change for the
worlds two largest
pension markets, new structures will let plan participants
move money into some of the highest-returning assets
Britains Pantheon Ventures and Partners Group of
Switzerland have spent several years developing private
equitycentered investment products that offer daily
valuations and liquidity for typically illiquid and quarterly
valued assets. Its the first step in a concerted effort
by private equity firms to tap the $15 trillion-plus defined
contribution pension market.
Goldman Sachs Group is also reportedly looking at ways to
introduce private equity into defined contribution plans.
Others are watching with interest. For private equity it
is the holy grail, says William Gilmore, senior
investment manager for private equity at $504.1 billion,
Aberdeen Asset Management. How do you get all that DC
money channeled into the industry? If we could crack that, we
would be happy.
By dealing with structural roadblocks, private equity firms
will give defined contribution plans access to private equity
and other alternative assets such as infrastructure and
unsecured mezzanine debt. Unlike existing liquid alternatives
funds, the new products aim to tap the full illiquidity premium
that long-term alternatives can yield. But they face other
challenges, including the shift toward low-cost investment
options and concerns about risky investments that might blow up
and leave savers out of pocket and fiduciaries humiliated.
Defined contribution programs represent 46.7 percent of the
$32.9 trillion in pension assets in the top six markets
worldwide, according to New Yorkbased consulting firm
Towers Watson & Co., making them too big for private equity
managers to ignore any longer. For their part, defined
contribution plans cant overlook higher-yielding asset
classes as fixed-income returns compress. In the U.S. such
schemes posted average annualized returns of 6.85 percent from
1997 to 2013, while their defined benefit rivals returned 7.92
percent, Toronto-based data provider CEM Benchmarking
If the only retirement assets that an individual is
going to have are DC assets, there is no reason they
shouldnt have the same powerful tools as DB investors
have had, says Kevin Albert, global head of business
development at London-based Pantheon. If private equity
makes sense in a DB plan, it has to make sense in a DC
Pantheon expects to have two large corporate pension plans
signed up for its new U.S. investment product later this year.
The $31.4 billion firm is structuring private equity components
for bigger target date funds, which could provide, say, 10
percent exposure to the asset class for plan participants early
in their career and reduce it as they near retirement. For that
portion of the fund, liquidity will come from listed
investments comprising as much as 30 percent; Pantheon will
create daily valuations using underlying quarterly private
equity valuations and daily movements of the S&P 500
indexs constituent stocks, along with macroeconomic
Zug, Switzerlandbased Partners aims to attract U.K.
and U.S. plans with packages consisting of private equity
funds, direct investments, infrastructure and private debt. The
firm hopes to satisfy liquidity needs by investing in
more-tradeable forms of debt such as senior and mezzanine
loans, as well as publicly listed infrastructure. Like
Pantheon, it wants to be part of an auto-enrollment option or
default selection for savers who tend to go for little
We would love to see an investment structure from the
private equity industry that solves the problem of getting into
DC portfolios, says Nico Aspinall, London-based head of
U.K. defined contribution consulting at Towers Watson.
That structuring question is the DC challenge to the
private equity industry, adds Aspinall, whose firm has $2
trillion in assets under advisory for pension funds and other
investors. This applies to hedge funds as well. We would
love to see more of them in DC.
But structuring products is only part of the issue.
Private equity, like hedge funds, is sticking to its 2
percent annual management fee and 20 percent performance fee as
pressure to reduce such costs grows. In April the British
government introduced a 75-basis-point charge cap on defined
contribution default funds; all funds may eventually have to
match the 50 basis points set by the National Employment
Savings Trust that it established in 2010 to manage pensions
for businesses without their own programs.
The 75-basis-point cap is very tight, even if you
create a diversified portfolio with some more-liquid elements
that come at lower costs, says Steffen Meister, partner
and delegate of the board of directors at $45.5 billion
Partners. If it goes to 50 basis points, I think that is
probably going to pretty much stop all private markets
Fear is another factor. Even within a corporation with
legacy defined benefit pension liabilities and a newer defined
contribution plan, opposing forces are at work. A defined
benefit plan can ride peaks and troughs in returns, but defined
contribution fiduciaries fret about explaining bad deals, which
cost participants directly.
Still, with products from Pantheon and Partners close to
adoption, private equity, hedge funds and other illiquid
alternatives will likely be part of the mix for many defined
contribution pension schemes within five years. We think
low-cost beta coupled with sophisticated alpha is the
future, Towers Watsons Aspinall says.