Innovation and growth in UK pensions | unleashing the potential of unlisted equities

UK pensions are progressing the greater inclusion of unlisted equities to ensure better returns for savers and drive growth. The City of London Corporation, with support from EY, convened industry leaders at the Mansion House Pensions Summit in October. This move coincided with the Chancellor of the Exchequer’s renewed endorsement of the Mansion House Compact, pledging £320m in the Autumn Statement to deliver pensions reform, alongside an additional signatory, Aon, pledging to allocate at least 5% of Defined Contribution (DC) pension funds to unlisted equities by 2030.

The Mansion House Compact states an ambition to unlock £50bn by the end of the decade, ensuring fast-growing businesses in sectors like fintech and biotech can stay and scale in the UK and securing better returns for savers.

At the Summit, the discussions focused on key areas for advancing the pensions ecosystem: Trust, Transactions, and Tools & Talent

Trust in the asset class

Unlisted equities provide diversification, the potential for higher returns and a way to support innovative UK companies that can unlock growth and improve retirement outcomes. Despite this, in the UK prior to the Mansion House Compact DC pension schemes invested only 0.5% into unlisted companies.

While, encouragingly, this asset class has recently piqued the interest of pension funds across the UK, trust remains a pivotal factor in their adoption.

Ultimately many attendees of the Mansion House summit argued it came down to education on the buy-side to build trust in this asset class

Employers need to explain why they are making changes to DC default strategies and investment in this asset class often incurs higher fees, while offering the potential for higher returns. It is easier to explain changes driven by lowering the costs or fees. However, how do they justify now changing to a strategy which incurs higher fees? The fee structure and the way ‘fees’ are shown discourages interesting investment choices. But ultimately many attendees of the Mansion House summit argued it came down to education on the buy-side to build trust in this asset class given the cultural focus on low costs and the need for employers and trustees to think about the longer term value of their investments.

At the trustee level, there have been positive developments. There is a growing appreciation for the potential of unlisted equities, driven by the need to achieve better returns. Different parts of the value chain are now actively seeking information and education to enhance their understanding of this asset class.

But more needs to be done to help members fully understand what is in their default fund and the added value from these investments. And to become more familiar with unlisted equities as an asset class and engaged with both the composition of their pensions and benefits from increased contributions.

This will help build trust in this asset class and change the narrative throughout the pensions value chain from 'this is your cheapest' option to 'this is the best value' one.

Transactions and easier access

Attendees also highlighted the fee structure and pricing mechanisms of vehicles that invest in unlisted equities as a barrier to entry for DC schemes. Some suggested smoothing performance fees over time or backloading them. They also raised the need for more clarity around pricing mechanisms and more consistency in methods to value private assets.

Liquidity was a concern for some, particularly in how capital gets deployed initially. Many questioned the necessity of daily liquidity for all portfolio assets if the scheme itself met overall liquidity requirements. Scale and consolidation were cited as a connected solution to liquidity concerns. Collective DC schemes are conceptually better placed to pool assets and invest collectively in the interest of savers. Many ideas were shared, such as more co-investment that would help to bring fees and risk down – a common practice in VC more widely. Pooled funds, a pooled vehicle, or funds-of-funds that aggregate assets from smaller DC schemes would allow pension funds to access unlisted equities with lower entry requirements.

The default investment strategy came into question. Should it be adjusted to incorporate unlisted equities? What defines a 'good' policy — low fees or one that fosters economic growth? There's a need to discuss the criteria for a 'good' policy and ensure its accessibility across the entire value chain.

What defines a 'good' policy — low fees or one that fosters economic growth? There's a need to discuss the criteria for a 'good' policy and ensure its accessibility across the entire value chain.

Tools & talent for the ecosystem

The UK pension landscape is undergoing a transformation as pension funds increasingly explore investing in unlisted equities. There is a shift already taking place as we are seeing more and more roles carved out at pensions funds for people with experience in high growth sectors such as Tech or Life Sciences in pensions than ever before.

However, investing in unlisted equities demands a unique set of skills, including expertise in due diligence, valuation, and governance specific to private investments. These skills are often distinct from those required for managing traditional assets like stocks and bonds.

To overcome the talent challenge, hiring or partnering with professionals experienced in unlisted equities can provide guidance to navigate this asset class effectively. A collaborative approach among industry stakeholders is essential. Pension funds, consultants and asset managers need to collaborate to foster a culture of learning and expertise in unlisted equities. Employers and Scheme Sponsors also have a duty to improve their understanding of the role of unlisted equities in a well-diversified portfolio.

In addition to building the expertise on unlisted equities admin systems/platforms used need to be able to accommodate private assets. Commercial managers mentioned they could create the best investment offer, but if a platform cannot work with it, that is a blocker. Admin systems need to be able to evolve to meet new liquidity dynamics including how daily valuations on private assets were cited as not being needed. The industry needs to create that long term horizon. The Long Term Asset Fund is one recent innovation that has helped in this space by solving the liquidity mismatch between the permit of a daily dealt fund and long term illiquid underlying assets, but it is not the silver bullet.

The shift toward unlisted equities in the UK pension ecosystem is promising, but it necessitates continuing to build trust, expanding access to the asset class transactions and nurturing the expertise and tools required to navigate this asset class successfully. There is a real opportunity to create an environment where DC schemes can harness the opportunities they represent in terms of growth and contribute to better retirement outcomes for people across the UK.

The need to fully implement a programme of change for UK pension funds to raise investment levels – including the Compact – was highlighted as a 'big move' in the Corporation's report, Vision for Economic Growth - a roadmap to prosperity.

What’s clear is the need for supportive, stable public policy and greater collaboration between actors across the pensions value chain. The City of London Corporation has kick-started efforts with the Compact and encouraged a collective dialogue via the Summit. While setting out some of the changes needed in Vision for Economic Growth.. The industry, regulators and government are aligned on the desired outcomes and there’s a good deal of enthusiasm to shift the culture from cost to value in the interests of savers.