Private equity and real estate investments, as proposed by Schroders Capital, potentially reduce overall volatility in defined contribution (DC) pension schemes.
Private markets are increasingly being recognised as a valuable addition to defined contribution (DC) pension schemes. These asset classes, which include private credit, private equity, real estate, and infrastructure, can help lower overall volatility and provide a volatility-dampening potential.
One of the key advantages of private markets is their resilience to short-term market noise. Unlike listed equities, private markets do not react in the same way to short-term fluctuations, making them a stable anchor for DC portfolios.
A study by Schroders Capital found that private equity investments outperformed public markets by an average of 4% net over the 25 years to 2024. This outperformance, coupled with their low correlation to public markets, makes private assets an attractive option for diversifying returns and performance.
The long-term horizon of DC portfolios, which includes private market assets, can be an advantage in terms of accessing the potential illiquidity premium. The illiquidity premium in DC default strategy, especially in accumulation, can be an advantage rather than a drawback.
However, the inclusion of private markets in DC portfolios raises questions around transparency, liquidity, and valuation lag. Valuation lags in private assets can serve to smooth returns and reduce portfolio churn. Less frequent valuations in private markets lead to a natural smoothing of returns.
Despite these considerations, many pension firms have pledged to invest 10% of their assets in private markets by 2030. Market volatility can be smoothed by including private markets in an investment journey.
Schroders Capital believes that private markets could play a key role in helping investors weather market storms. The performance of private markets often diverges from the public portion of a portfolio, providing a valuable source of stability during turbulent times.
As DC scheme members witness steady performance, they are more likely to stay the course and remain engaged with their savings. The name of the solutions strategist at Schroders Capital who speaks about incorporating private market assets into defined contribution pension funds as a means to reduce overall volatility is not publicly available.
In conclusion, private markets offer a promising avenue for DC pension schemes to reduce volatility and provide a more stable investment journey for their members. While questions around transparency, liquidity, and valuation lag are valid, they are outweighed by the potential benefits private markets can bring.
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