Pension fund investment in non-listed assets has grown considerably since the 2008 global financial crisis.
Investing in private markets, including private equity, private debt, real estate and infrastructure, has helped funds to reach their target returns more comfortably in a decade characterised by low yields.
Greater allocations to non-listed assets have also been a key factor enabling pension funds to ride out the market volatility caused by the COVID-19 pandemic.
With lower future expected returns in most asset classes, pension funds will be compelled to raise their allocation to higher-yielding, less-volatile, non-listed assets in the years to come. However, the cost of investing in private markets remains extremely high.
For many pension funds, the fees charged by private-market funds tip the overall cost balance over what is considered an efficient or acceptable level per member.
This is especially true within the emerging defined contribution sector. However, there is no realistic alternative for most pension funds. Restricting the asset allocation to listed assets means having to endure higher volatility and running the risk of not meeting return targets.
The many debates over fee levels, cost transparency and the value for money of asset management services has yielded significant results in liquid markets. Faced with the risk of seeing their clients choose cheap passive strategies, active managers of listed assets have simply had to lower their ad-valorem fees or seek alternative, performance-based arrangements.
The same has not happened to a significant extent among private market managers. This is apparently because of the simple fact that institutional demand for private market investments exceeds supply.
However, supply-and-demand dynamics only tell one side of the story. When it comes to high-yielding private equity funds, for instance, investors could also be experiencing a fear of missing out on returns or adopting cult-like behaviour towards the asset class. This is perhaps why the largest funds are experiencing the largest inflows of assets.
Furthermore, while the transparency of private equity funds has improved significantly over the years, there has been little differentiation of fee structures. The typical manager continues to offer the traditional two-and-20 structure.
Pension funds with no choice but to invest in private markets should forcefully seek solutions to reduce their fee burden from such investments. Among these, they should ensure that the outperformance generated by managers is split fairly.
Another possibility is to team up with other investors, through co-investments or other structures, in order to gain leverage with private capital managers. The added risk of working with smaller, less established private capital funds should also be weighed against the lower fees they charge.
Whatever the practical solution, pension funds have a right, and to some extent a duty, to individually and collectively demand lower fees. The private capital industry might be booming. But that is no reason for pension fund members to bear the cost of excessively high asset management fees in order to secure an adequate retirement.
Carlo Svaluto Moreolo, Senior Staff Writer,