Attention on private assets or illiquid investing in the UK has recently increased for the pensions sector. This is due in part to the so-called ‘Mansion House Reforms’ introduced in July 2023 by the then Chancellor, Jeremy Hunt. The reforms have a dual aim; to enhance returns for pension fund savers whilst also increasing funding for UK companies by boosting investment in private markets.
As the dust settles on the announcements, pension schemes are starting to grapple with the practicalities of implementing these reforms.
What has been announced?
On 10 July 2023, the Chancellor announced a series of reforms to boost pensions and increase investment in UK businesses. Of particular focus for this blog are:
- Support for the ‘Mansion House Compact’: an agreement between 10 of the largest Defined Contribution (or DC) Schemes to invest 5% of their default funds to unlisted equities by 2030, with the hope that other providers will follow suit.
- For Local Government Pension Schemes (LGPS), a consultation launched on setting an ambition to double existing investment in private equity to 10%.
Subsequently, the then Chancellor announced at the 2024 Spring budget (2 March 2024) that DC and LGPS schemes should publicly disclose their level of investment in UK businesses.
The message from the then Chancellor was clear; pension schemes should be investing to benefit the UK economy. But can these benefits extend beyond the purely financial?
What is the current state of play?
Defined Contribution (DC) schemes were only introduced in the UK in the 80s. It has taken time for this type of scheme to gain the scale that its predecessor (the Defined Benefit or DB Scheme) has had. However, thanks to the closure of many DB Schemes and the introduction of automatic enrolment, we are gradually seeing the size of DC Schemes increase. It is estimated that DC assets will reach £1trn by 2030 compared to £1.5trn for DB.
As DC schemes’ scale increases, so does their ability to invest in private or illiquid assets. However, investment in private or illiquid assets by DC schemes has been limited to date. This is driven by both a focus on keeping costs low for DC Scheme members and also DC fund structures desiring the ability to price and trade daily.
Times are changing however. Various market and regulatory developments have led DC schemes to revisit their private asset allocations. These include (for example):
- new fund structures such as Long-term Asset Funds (LTAFs);
- a vibrant secondaries market providing quasi-liquidity for investors looking to re-sell their investments in private equity funds and other private investment funds;
- Multi asset strategy approaches that enable investors to meet their liquidity needs alongside accessing private markets
- the rise of real estate fund strategies tracking long-term demographic and other secular trends, such as social housing, senior living, student accommodation, Build-to-Rent (BtR) etc.; and
- co-investments opportunities with potential for bespoke fee arrangements.
These developments along with an increased recognition of the return potential and diversification benefit (amongst other benefits) of such investments have led DC schemes to revisit their private asset allocations.
LGPS on the other hand already have a strong track record in investing in private assets. The then-chancellor seemingly just wants to see more of that investment in the UK.
How will the election result impact this?
The Labour party manifesto said that it would act to increase investment from pension funds in UK markets. This includes by adopting reforms to ensure that workplace pension schemes take advantage of consolidation and scale, and to deliver better returns for UK savers and greater productive investment for the UK as a whole.
The Kings Speech on 17th July outlined plans for a new Pension Schemes Bill and on 21st July the new Labour Chancellor, Rachel Reeves launched a "landmark review" into pensions which, will include considering productive investment. This seems aligned with the Spring budget announcement and Mansion House reforms, so we can expect these to continue as outlined with possible further development.
But what is the connection to Society?
A raft of studies agree that areas of the UK economy have been financially constrained over the last decade or more:
- Charities like Shelter continue to highlight the supply/demand imbalance in social housing, citing statistics of over 1 million households waiting for socially affordable homes.
- In September last year we saw NHS England tell hospitals to be ready to evacuate if buildings crumble. Investment in social infrastructure is needed.
- It is estimated that there are c. 5.5 million small and mid-sized enterprises (SMEs) in the UK representing over 99% of all UK businesses. A report for the Levelling Up Advisory Council published in March 2024 found that the MacMillan Gap (being the funding shortfall that starves SMEs of the capital required to grow) is currently over £11bn.
- With a forward-looking view, the latest assessment by the National Infrastructure Commission highlights the need for investment to decarbonise our economy and reduce our exposure to climate risks. In fact, the same National Infrastructure Commission assessment estimates that private investment in the UK will need to increase by £10 to £20 billion over the next two decades as we transition to a low-carbon economy.
There is therefore a real chance for private investment to help with societal challenges, whilst capturing return targets up to the high teens. The Chancellor’s focus on private equity to help boost the UK economy is not unusual; Professor Robert Eccles of Said Business School once described the private equity sector as the “transformation engine” for progress towards a more sustainable economy.
Legal considerations
Of course, as fiduciaries of members' benefits, trustees must consider the risk-adjusted return potential of their investment choices. But, the case for private investment has long been touted, with the so-called “illiquidity premium” offering a potential uplift for investors in private assets. Indeed, in their proposals, the Government estimated a 5% uplift in pension pots after 30 years with a 5% private equity allocation away from bonds. Clearly, there are several assumptions underlying this. However, the investment case for illiquidity is already there and there is a case for these to have a social impact alongside other social investments.
A key focus over recent years, and heavily reinforced in the 2024 Spring Budget is value for money. The Department for Work and Pensions, the Pensions Regulator and the Financial Conduct Authority have developed the value for money framework which is clear that value for money does not just mean low fees but also getting good value from investments over the appropriate time horizon. It is hoped that this framework will give Trustees the opportunity to invest in more diverse asset classes including illiquid assets.
Long Term Asset Funds (LTAFs)
Much consideration is also being given to the new LTAF legal framework to facilitate illiquid investments, which compliments the range of other alternative investment structures and strategies developed by the market overthe years. LTAFs seem to make a lot of sense and potentially give Trustees access to illiquid assets.
The devil will, however, be in the detail with these funds. For example, the FCA requires a minimum 90-day noticeperiod for redemption with some funds requiring longer periods depending on the assets held.
Investing in structures of this nature is relatively new to the vast majority of Trustees and the pensions market generally. If considering investing in structures like LTAFs, Trustees should consider whether they and their existing advisershave the requisite skills and experience, or whether other specialist advisers will be required.
Common themes
Whether investing in private or illiquid assets through LTAFs or alternative investment structures such as
private equity, debt, real estate, infrastructure, venture capital and hedge funds there will generally be a common set of core themes relevant for Trustees and their advisers.
From a legal advisory perspective, some of these due diligence themes include (amongst others) governance,
transparency, reporting, investment policies and limits, fees and ongoing costs, and “side” rights and protections for Trustees, DC Schemes and their members.
In addition to due diligence, Trustees will need to consider their own governing documents and statements of investment principles to ensure that they have the appropriate powers to invest in alternative assets and investment vehicles.
What can we do to help?
Investment opportunities with a social impact require in depth due diligence to ensure the investment manager is able to deliver not only the investment return expected but also the social impact desired. Barnett Waddingham have strong experience in helping clients with sourcing such investment manager appointments.
DWF's Pension and Investment Funds groups work together to assist pension investor clients with their
investments across all alternative asset classes and investment strategies, including LTAFs and other alternative funds outlined in this article. Our services also include:
- Reviewing and analysing investment fund terms, drawing upon our extensive knowledge of the market
- Negotiating side letters rights and fund documentation amendments
- Reviewing fund investments for tax, regulatory and ESG issues
- Advising on key person, removal and other fund events
- Advising on secondaries (i.e. selling and buying interests in private investment funds).
We would like to thank Clare Keefe for her contributions to this article.
