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Defined Contribution

European funds embracing private market investments

Ralph Frank called the situation surrounding private funds a ‘chicken-and-egg situation.’

Alternative options up as pooled structures ease liquidity issues

European defined contribution plans of all shapes and sizes are moving to include private market assets into their default funds, making use of liquidity-friendly pooled fund structures.

Liquidity requirements historically have limited defined contribution plans' efforts to invest in alternatives in many jurisdictions, including the U.S. and the U.K. Investments in private markets and infrastructure, which have formed part of defined benefit fund allocations for years, were considered unobtainable in the DC environment because of the need to provide daily valuation of assets and to have the capability for quick liquidation of assets due to the portable nature of DC accounts.

Those restraints not only kept DC plan executives from pursuing such investments, but they also provided a disincentive to money managers to expand their offerings.

"It is a bit of a chicken-and-egg situation. Plans were asking how this investment aligns with my objective and how does it contribute vs. what is available in the market and implementable," said Ralph Frank, head of DC at consulting firm Cardano in London.

But this is slowly changing. In Europe, DC plans now have access to a greater breadth of strategies, offering elements of private infrastructure, credit, real estate and equity investment options compared to previous years, sources say. In the more mature DC markets, including the U.K. and Italy, managers say plan sponsors want to diversify from concentrated public equity markets into alternatives.

But diversification is not the only reason asset owners are looking for this kind of exposure. An allocation between 10% and 15% to real assets, including real estate and private markets, can provide a degree of inflation protection and a return pickup at the same time, said Marc Haynes, head of institutional business, Europe Middle East Africa, at Cohen & Steers in London.

Since DC plan executives in the past few years settled operational challenges stemming from other regulatory priorities — like consolidation into multiemployer funds, compliance with U.K. master trust regulations and U.K. rules that did away with the requirement that retirees purchase an annuity — European plans are now showing signs of increased consideration for spicing up allocations, moving beyond the more familiar real estate.

In the U.K. 47% of the 19 largest master trusts already include a property allocation in their default options, according to April data from Defaqto, a financial information firm in Haddenham, England. By comparison, in the U.S. the average DC plan allocation to real estate vehicles was 0.4% as of March 31, according to Callan LLC.

Addressing a need

Peter McKellar, global head of private markets at Aberdeen Standard Investments in London, said developments in private markets' investment offerings for defined contribution plans are "a confluence of the (asset owners') need to obtain the return and (the) market seeking to address that need."

And because DC plans can already get the needed liquidity through existing fund structures, money managers say clients are seeking paths into infrastructure and private credit exposures.

Victoria d'Avanzo, vice president, client solutions at Partners Group AG in London, said products with daily valuations already are available in the U.K. market. She said her firm's Generations Fund, a blended private markets fund, "allows for 10% liquidity of the total fund size per day, 25% per 30 days and a 40% liquidity per annum on a rolling basis."

The Partners Group's fund is coming up to $300 million in assets under management from U.K. defined contribution plans. "The fund targets 100% allocations in private markets, including a 25% exposure to listed private markets. Some 35% is semi-liquid private market exposures, such as high yield and syndicated loans. The remaining 40% allocation is invested in illiquid private markets: private equity, real estate and private infrastructure," Ms. d'Avanzo said. She declined to identify any clients.

In Italy, thanks to legislation passed in 2015, private markets investing has opened up to occupational defined contribution and social security funds. The law allowed investments in alternatives to be as much as 30% of a fund's assets, up from zero, in efforts to support the growth of the Italian economy.

Despite that legislative green light, not all alternatives are viewed equally. Italian asset owners are not necessarily looking for exposure to direct infrastructure investments, in part because of daily valuation requirements, sources said.

Demand for infrastructure

The most significant demand is for infrastructure debt and equity, said Alberto D'Avenia at Allianz Global Investors in Milan. Investors are seeking funds "that would have between 12 and ... 20 years' investment horizon, with investment-grade quality," he said.

DC plan executives' interest in its now €100 million ($116 million) infrastructure debt strategy has prompted AllianzGI to launch a parallel private credit strategy, called "resilient credit," which invests in hybrid core-plus infrastructure projects that support the construction of roads and electrical generators globally. "Because debt (maturity) in this fund is shorter, the investment horizon is shorter," Mr. D'Avenia said.

A number of DC plans are on the hunt for managers to run new private markets allocations.

The €11 billion Fondo Pensione Previndai, Rome, is the most recent Italian asset owner to launch a search for managers to run closed-end alternative strategies covering infrastructure, private equity and direct lending in its two portfolios valued at €1.9 billion.

The U.K.'s National Employment Savings Trust, London, is gearing up to launch infrastructure debt and private credit manager searches in the coming months, a spokeswoman at the 2.5 billion ($3.4 billion) multiemployer plan said, declining to provide details.

And money managers that are working on or considering private markets strategies for DC plans might soon receive an added boost. Despite a cap of 75 basis points on costs for U.K. plans' default funds, the government is expected to recommend by the fall that U.K. plans make private markets a greater priority, said one source who had been invited to participate in government-led discussions.

Cohen & Steers' Mr. Haynes added that "NEST is making very advanced moves compared to a typical DC plan. The reality is still very few plans invest in real assets compared to their defined benefit counterparts." Cohen & Steers rolled out its Diversified Real Assets strategy earlier this year for U.K. DC plans and is about to bring its first two U.K. DC clients on board. "One of them is a corporate DC plan," Mr. Haynes said, declining to identify the clients further. The strategy combines exposures to global listed infrastructure, listed real estate and commodities and natural resources equities.