Alternative, and essential: The case for private market allocations in UK Defined Contribution (DC) plans.
Authors
Aaron Hussein, Global Market Strategist,
Catherine Duncan, Client Advisor
Philip Waller Investment Specialist, Alternatives Solutions
In brief
- The evolving global landscape is posing significant challenges to the traditional 60/40 portfolio, making it increasingly difficult for DC investors to achieve the best possible outcomes for members if allocating solely to public markets.
- Alternatives offer diversified income streams, inflation protection, and enhanced returns through opportunities not available in public markets. Previously constrained by regulation and cost, trustees now benefit from a more supportive environment for accessing illiquid and alternative investments.
- DC members have historically missed out on investment opportunities available to their DB counterparts. The industry-led Productive Finance Working Group (PFWG) is working to ensure that DC schemes have access to a wide range of investment opportunities to help members reach their retirement savings goals.
- There remain a number of challenges which DC investors will face when allocating towards private markets, including increased cost, liquidity constraints and how to appropriately educate trustees and members on these new asset classes.
Alternatives are essential for a changing world
The world is evolving in ways that challenge the risk-adjusted returns investors might achieve by allocating solely to public market assets. We identify three key changes that require alternative asset solutions: Higher and more volatile inflation, the changing structure of capital markets, and the market’s ambitious environmental, social, and governance (ESG) goals.
Alternatives can provide broader diversification and protection from inflation
Inflation is expected to be higher and more volatile over the next decade, posing a risk to DC pension scheme members by eroding their retirement savings. The Pensions and Lifetime Savings Association (PLSA) reports that the cost of a moderate retirement living standard has risen to £23,300 per year for a single person and £34,000 per year for a couple.
Since stocks and bonds often underperform during periods of unanticipated inflation, DC investors should explore a diversified strategy that not only includes built-in inflation protection but also taps into asset classes with the potential for higher absolute returns. Real assets such as real estate, infrastructure, transport, and timber offer protection from inflation, while private equity investments present opportunities for higher absolute returns and the potential to capture illiquidity premiums.
By combining these attributes, private markets can play a pivotal role in helping preserve the value of retirement savings. This approach ensures that retirement portfolios are better insulated against the erosive effects of inflation, thereby enhancing the prospects for achieving long-term financial goals.
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