When it comes to illiquid investments, can the UK emulate Australia?

Mike Ambery: Hello and welcome to the latest episode of Thinking Forward. With myself, Mike Ambery where we're here to explore the trends and developments affecting the UK pensions industry. Today we're here to talk all things Australia, which some of you will know is a mature pensions market that we often think we could emulate or learn from. 

Discussion is over a series of episodes and this one will focus on domestic equities and private markets. I'm lucky enough for this discussion to be joined by John Greenwood, Editor of Corporate Adviser, Paul Leandro, Partner from Barnett Waddingham, and the Friday Drop superstar and Senior Leader in our Proposition Management at Standard Life, Femi Adigun. Thank you all for being here. 

So moving on to the topic at hand in Australia. Super funds dominate, illiquid investments are more common. And so are average pension returns higher than that in the UK. The inclusion of private assets in portfolios has, over a lengthy period, been trying to deliver optimal risk-adjusted net benefit outcomes for members. So looking at today's Australian super averages and investments, around 30% of their assets in private markets, which includes property, infrastructure, private equity and credit and also venture capital, I guess it’s what can we learn. 

So I’ll start off with the first question, if that's okay? And John, I'll give you the heads up that’ll I'll come to you first if that's all right? So on the face of it, with Australia, investment experience would overwhelmingly support the ambitions from Mansion House back in July 2023. The why, to invest in illiquids is, I think understood. The how is a bit more of a trickier sort of question. So I guess there's a lot of money chasing, most funds once invested hold onto those key opportunities. What do you think? Will it increase competition? Is it a good thing?  

John Greenwood: I mean, I think, to start off with, I think it's fair to say that, there's a bit of a cultural thing that we've got to get over here in the UK, particularly for the DC sector, the DC sector don't even really like, active management. You know, that's a bit of a step far. 

So to go and say to people, yeah, we're going to go with this private equity manager who actually their returns are cloaked in secrecy, but trust us, it's going to work. That's going to be a big cultural step. It's not just the DC sector. I saw a report the other day, it was the 150 biggest holders of private equity in the world. And of the 150, only three of them were based in the UK, which I thought, this sort of speaks to exactly what you're saying. 

Feels like it's a cultural thing, but obviously is it a good idea? There's a lot of money chasing. You know, listed equities as well. So I think that's the reality of the wealth of the world growing. Obviously, you've got big players around the world doing it. They're not idiots, I'm guessing. 

So, you know, all of those American, Australian, Canadian pension schemes, you know, these big, big investment vehicles. I'm sure they're finding value. I think it is a question of it's not a question of should we? It's a question of, as you say, as to the how. 

Mike Ambery: Excellent, thanks John. Paul, I don't know whether you've got other reflections?  

Paul Leandro: I'll pick up on that competition point, because competition. Well, it's fierce at the moment and it's only going to get more fierce. And as you say, John, we've got, you know, you've got Australian pension funds, which are huge in scale, certainly compared to the UK. Canadian funds, sovereign wealth funds, other institutional investors who are already in the UK investing in illiquids and we know that they're thinking of ramping up as well, you know, so the Australian super funds are setting up offices in London you know ready for discharge. So competition is fierce. 

Arguably in isolation, you know, the large master trusts, the large pension schemes in the UK won't be able to compete. So we're probably looking at an environment where, partnerships are going to have to come to the fore. 

The master trusts, pension providers are gonna have to team up with asset managers who have deep pockets, and deep expertise of how to do this. So it's going to be interesting to see how the market reacts to this, but I think there needs to be some quite seismic changes, if the UK market is going to compete with the global competitors.  

Mike Ambery: Brilliant, Paul. Thank you. Femi, I don't know whether you've got any views on elbowing competition out or any particular views on this as well? 

Femi Adigun: Yeah, I think to add a bit more context. So private markets typically have a long time horizon. I’m 28, my retirement dates going to be 2060s. I would say, you know, someone especially like myself, young pension scheme member. This is definitely something I probably want my money to be invested in. I think when we look at mortality challenges and people are living longer lives. The macro landscape’s fundamentally changed. 

And so, you know, some of the comments that you were making earlier John, about only three of those companies being part of the UK, in that list is important because when you look at, you know, medium sized companies, for example, there’s about, I think just under 40K, 40,000 medium sized companies in the UK. And of that less than 2,000 are listed. 

So the opportunity is definitely there. I think the key thing for me, though, is portfolio construction. You'll probably want a fund or a private markets fund that is close to I'd say 90% illiquid or has illiquid assets. And then the other thing is, you know, I think private equity has enjoyed low interest rates. We’re now in a different regime and so, you know, looking at opportunities, I think that's where that competition piece comes from. How can you partner with good asset managers to deliver that aim?  

Mike Ambery: That's brilliant. Thanks, Femi. I’m just going to pick up from you, Paul, whether you've got a response on that?  

Paul Leandro: Well it’s just that point on like investment assumptions. So I was speaking to an investment colleague about all this yesterday. Her words were that the Mansion House assumptions are pretty heroic, not just from an investment performance perspective, but also from a charges perspective. 

If Mansion House is going to be successful, it assumes quite discounted fees. But then back to the competition point, if the competition is fierce, you know, demand for these assets is huge. That's not going to lead to discounted fees. Quite the opposite. I completely agree with that. I guess the other question I have is economies of scale as well. 

You referenced supers are much larger is what, 200 billion pounds in value, 300 billion AUD? I guess that sort of competition. John, I don't know whether you have a thought of do we need to increase consolidation before we do this to maximise our opportunity within the UK?  

John Greenwood: I'd actually possibly, controversially, say that most of the UK DC sector is quite concentrated now. We ran some numbers from our Master trusts and GPP report for one that you know, I think the greatest, you know, the top the biggest probably six or eight providers in the UK have a greater percentage of savers than those in Australia. Australia's so far ahead. They're like what, 30, 32 years into this now they've got higher contribution rates. They've benefitted from a big, you know, natural resources boom in their home country. 

So they've had some tailwinds behind them. But funnily enough, it feels like having done that research every year on the growth in the DC sector, in the last year, the multi-employer schemes that we look at the Master trusts and GPPs added something like 115 billion in 2023, that's a lot of money and I suddenly felt that we're getting to a point that in a few years’ time we are going to have the scale, you know, 10 years from now, what we're going to look like a pretty big DC market. 

And then 10 years after that, the direction of travel is that it's going to happen. But to your point now, we haven't got the scale. If you leave aside the however many there are single employer trusts, we're probably more concentrated in terms of, members with providers than, Australia. So I think it's a case of time.  

Mike Ambery: I agree with you. You talk there and I'll move on to another question. What is sort of scale and sort of doubling assets under management every 5 to 10 years, depending how you look at things. Australia's a 4 trillion pound market at the minute. So it's pretty large and that doubling every five years, is worrying for that level of competition. 

But we spoke to Paul Watson, a friend of Standard Life earlier this year, who cited a few of the factors for executing Mansion House compact strategy. With regard to illiquid assets, one of those is scale. Another is sort of demographics, the age of the population that you're looking after, tolerance of illiquidity. And we see different products in private markets introduced probably over the last month or two, which has different levels of illiquidity. And we also go back down to resilient investment beliefs and strategy as well. Paul, I'll turn to you for, do you agree those are the right factors? And how do we sort of demystify them and think through that? 

Paul Leandro: So I, I do agree with those factors actually. And yeah, I mean, you mentioned it. I mean, the focus here is on scale. I'll tell you a couple of other things to consider here as well. So just drilling down into the liquidity point, I mean, this was it's quite, quite pointed to me the first, first time I went to Australia, which was 2014. And we wanted to get ready to do our heads around what does illiquid investment look like? What does it really mean? How's it structured? 

And I ask that, you know, that liquidity question, you know, if you're investing so much in infrastructure, other illiquids, is liquidity an issue? And the thing is where's the level of contributions going in? I asked the head of Aussie Super that question. And he said when you've got $6 billion coming in every year, I mean it's doubled now. Liquidity is not an issue. You know, we're going to be talking about this. I'm sure, later on. 

But looking at the, you know, the second stage of the pensions review, you know, I think there's just a bit of a wink wink, nudge nudge, you know, that liquidity is not an issue if we want to encourage the industry to be investing in infrastructure. A way to do that is to increase the level of contributions going into the system. So, dealing with adequacy, but also, you know, more contributions going in the more we can invest in the UK economy. Certainly via infrastructure. Linked to a point that John just made before in terms of mindset shift, I think that's another factor that we need to bring into this from an employer perspective. Because, there has to be a mindset shift from cost to value. 

So if we bring in more illiquid into default funds, it’s going to increase cost. And we're seeing, you know, lots of providers bringing, you know, an illiquid fund option to the table that employees could use as a default, but employers could be blinded by the cheaper option over here, not really appreciating the added value that illiquids could bring in. And I think when Paul was talking about, you know, how it's working in the Australian model, we always need to consider, you know, the UK context, and a key difference, you know, significant difference between the UK and Australia. 

In Australia the individual chooses a pension fund, in the UK the employer chooses a pension fund. And I know that this is a challenge which providers think about all the times. If we move to more illiquids, it could cause an issue. If you have employers choosing different funds, you know, if you have a bulk transfer of assets moving because an employer chooses a different provider, if there's, you know, lots locked in illiquids it could be very tricky to facilitate that transfer. 

Mike Ambery:  I'm going to stay on that just for a moment or two. I'm going to turn to you John because I think it is difficult for employers to understand what does a default how often should I look at it? Where's my governance committee? What are the performance tables I should look at? And I do know you have a very good performance table and I know Barnett’s equally have that good performance table. But do we actually see employers look and nudge and go, “Do you know what, I've got one default and there might be another default being introduced that brings in those private markets as you say Paul with greater fee but a greater fee a greater outcome.” Where do you think the imposition is in the sort of UK market right now for employers to engage?  

Paul Leandro: I think, obviously depends on the size and the type of the employer and the culture of the employer and you know, there's still quite a lot of, employers out there who, just see the DC scheme as something they want to do as easily as possible. So administration, ease for themselves was the primary reason for selection at the outset. Hopefully, the work that, you know, ourselves and others have been doing and also the drive of the VFM process is to get some sort of, Ofsted style ranking going so that everybody sees that these DC pots ultimately depend on how big they are. 

When you hit 67, 65, whatever it is, you decide to take them and that there's a huge difference in outcome between certain strategies and other strategies. So we're not there yet. But hopefully as people become, as the pots get bigger and as DC becomes the main go forward, retirement vehicle, hopefully people will start to take an interest in them to the extent that they do with their mortgages. And realise that, you know, this is going to have an impact on the outcome, but we're not there at the moment. I would suggest for most. 

Mike Ambery: I agree, John. Femi, I'll come back to the original question if it's okay and those factors. Is there anything that we're missing? I know, knowing you quite well, illiquidity and that tolerance of illiquidity might be one there might be others in investment beliefs and strategy. A parallel difference there in Australia. Sustainability stewardship and those sort of, investment factors that you consider on a regular basis may be different between the Antipodes and here. Have we got those factors right? 

Femi Adigun: Yeah. So the factors that you originally mentioned, I think they're all equally important. You know, scale can lead to large positive cash flows. And hopefully that's going to naturally lead to better, liquidity management. I think the key question comes back to how do you evolve your private market asset allocation? To deliver value for money. And I think it goes back to what you were saying, Paul, about actually the culture shift.

I think we look at the economy in a very linear way.  And actually we probably need to adopt more of a circular mindset. these are, in my case, these are future assets which can actually be used to drive real world change in some way, shape or form. I think the key thing that I think is probably missing, from those factors, or we could have, is need to revisit investment beliefs and really understand what do they mean for, what does long term horizons mean? 

How do your investment beliefs take to, you know, megatrends, whether that be demographic changes, you know, the need for decarbonisation because, you know, infrastructure is going to play a huge part in that decarbonisation targets and so on. The key thing I would want to ask back to this group, because I haven't had the luxury of going to Australia yet. Hopefully I do soon. Is sustainability a big thing for them over there? I know in the UK it's mandated, for trustees to consider it and stuff like that.  

John Greenwood: My experience, I don't know what you think, Paul, in my experience, is that it's not as high profile an issue as it is in the UK, In Europe. There's a big battle over coal over there, there's a lot more engagement with coal there than there is over here. But that's not based on much. So I'll defer to you on this one, Paul. The sentiment is exactly the same. 

So I've been over there three times now. And sustainability wasn't really high on the agenda, for what people wanted to talk to us about. The focus in Australia is very much on net investment performance. and there's a debate, you know, given the context that they are focused on coal, but the debate is what leads to best. They say outcomes is the best net performance. And that dichotomy between whether they should go for performance or whether they should be looking at sustainability and performance, is winning that race. 

Yeah. It makes you kind of think that Thatcher and her industrial revolution really impacted our UK economy and how we look at even sustainability right. Maybe we're a few years ahead than other players. I think it's an interesting I think it's an interesting because when we're on this journey of the world has to you know, decarbonise or, innovate and have more, you know, I guess green solutions. I wonder how key world players are going to impact that. Because ultimately, we all need to be on the same journey if we're going to achieve the same goal.  

Mike Ambery: Yeah, I guess with that Femi. For me, Australia's, well known for its mining communities. Whether it be sort of natural resources like coal, it could be other precious metals and otherwise. So I think for long as the world needs it and it's a good part of the Australian economy, it will continue to have the needs to be a shut off globally, the utilisation of fossil fuels. You're right in saying are the supers restricting against that activity or otherwise. No, not in the same restraint or otherwise that we have. But, John, I don’t know whether you have.  

John Greenwood: No, no, it's a slightly separate point, but I wanted to come back to Paul what's on the list there. The one point and it sort of relates something you said earlier and I think opacity and like you were talking about the charges and employers expecting, to have the lowest charges and having a culture of always accepting lowest charges and the blame game goes along the chain. Well, it's the employers so they want the cheapest charges and then it's the consultants are telling them we can get you the cheapest charges and that cultural thing of the consultant. And then the providers saying, well, actually we're trying to beef up the investment solutions with these more expensive things, but further down the chain, I've got some sympathy for the consultants because at the moment, and I've done this myself, trying to find the data on performance of illiquids is incredibly hard. It's very, very difficult to find it. 

And so we're being asked to make a bit of a leap of faith. So the one thing I would say is opacity is an issue and a greater transparency around performance data would really help paint the picture. I've not seen that many reports on you know, hard data on how well, private market assets have performed vs. these equities.  

Paul Leandro: So we're still waiting for it. I mean, we just, you know, keep on hearing the argument that, yeah, illiquids you're looking at J curve. It's going to take a couple of years before you start to see the outperformance. So I mean, which, causes a question in my mind around that demand because, not all consultants just go for the cheapest, John. 

Yeah, I can't remember the last time we, we recommended the cheapest option available. but to talk to an employer, you know, to take that leap of faith to go for an alternative default fund, which is effectively untested and more expensive is tricky. So, I mean, this is a question I've got for, the Standard Life crew. I mean, what are you seeing in terms of the level of demand for, you know, these new products and is it a concern?

I mean, are you are you building something effectively, waiting a couple of years to see where the outperformance is and then you expect people to buy, are you waiting to see that performance before that illiquid fund becomes the standard core default arrangement? 

Femi Adigun: I’m happy to take that. So I think it's twofold. I think ultimately, as you said yourself Paul, we have to kind of prove that it works in market. And it's not just necessarily proving to consultants, but actually that it delivers true value for money. And what does that kind of look like? 

So, I think the key thing will be how do you offer differentiated, value for money, you know, how do you deal with performance fees? Do you have, for example, a hurdle rate, that the manager has to hit, in order for them to generate performance fees and stuff like that. I think, it's one the industry is definitely still grappling with. I want to come back to the cost piece, because this is probably a slightly a bit controversial. 

I generally do think cost has stifled innovation throughout DC, but I also do think it could have potentially helped us actually build scale in places that we do need it and actually leverage a lot of our, relationships with asset managers. what I mean by that is if I'm correct, I think the Australian market still accesses, illiquids even passive investments are probably a higher fee than what we pay in the UK. So I think we've probably implemented unintentionally some good behaviours and some expectations of asset managers. It will just be a case of how that plays out in the future.  

Mike Ambery: Yeah, I have one other thing I see since launch of sort of private markets funds, LTAF funds for us, corporates have come to us to say we want to get into that. We're lucky enough we have some very good global clients that are asset managers that do work in finance, that say, I can see A, the level of research, what the level of liquidity is like, and we do believe there will be outcomes based upon performance, delivered from there. It really does sort of depend on the quality of what’s delivered in that private market and where it's going to invest and that level of research. 

Can you take a punt on certain areas of private markets that are, you know, adjacent to or directly linked to, say, infrastructure or energy? We know there's going to be a guaranteed level of return similar to a dividend. Do you get a return on that asset basis as well, which could also be guaranteed for certain bets in private markets that, generally will improve outcomes just because of that sort of guaranteed level of return. But you're right in saying you can't be too cautious over some of the aspects you're not gonna go over Femi’s list of several thousand companies that are unlisted. I certainly wouldn't want to be. 

And we would not be. And I'm not any provider in the market wouldn't be. You’re not just frittering of a sort of, can we spend members’ money in different places that won't deliver outcomes, so needs to be based upon that private market research that has existed for a long period of time to make it sort of set returns, as opposed to, you know, my Vegas trip or something like that, so to speak. If it’s okay, I'll come on to one quick question. For the audience. John, I'm going to turn to you and it's really on this. What are the chances and what are the chances of Mansion House achieving what it needs to? 

John Greenwood: So first off, do you think Mansion House and private markets will set itself off will be a success? Secondly, I think we've spoken about a little bit of education to the employer, but what are the main priorities of what we need to do if Mansion House is to be successful? 

I mean, I think you've probably got some providers have already hit the mansion House required percentage and most will go beyond that. You've had a bit of kickback against it with one provider and one big provider saying, they're not going to do it. I think it'll I don't think it will achieve quite what the government wants it to do, which is investment in the UK. 

The industry has been pretty robust in its challenge to the idea of mandating a UK bias. But yeah, I think it's overall it's been a good thing because anything that forces people to examine their beliefs and try harder to do things and to be honest, we all want the UK to be doing better, but we're going to do it in a way that's going to protect member interests. 

But it's still a question worth asking and it should be at the top of everyone's agenda. Why are we simply going for passives or, you know, just doing things the way we used to do? So I think it's been a very useful exercise. And as a result, there will be more, investments in private markets, and some of that will be in the UK as a result of the whole project. So I think it's been a worthwhile thing.  

Mike Ambery: So a win-win. Paul.  

Paul Leandro: If it’s going to work, I think we will need that framework in place where, you know, providers, asset managers can work together, to get around that issue of now, you know, if you want Mansion House to work now, we're investing in infrastructure, illiquids. Now we need to create that scale pretty quickly. We can't wait, you know, until asset size doubles. 

Because the providers and asset managers, they hold these assets for a long period of time. so when these things come to market, they need to be snapped up. So we need that scale now, from a policy perspective, I think, yeah, whoever's writing the policy needs to be cognisant of unintended consequences. So, for example, and I know this is a subject for a future podcast. 

But, looking at the proposed the VFM regs, for example, focused on backward looking investment performance. If we want to encourage more investment, in illiquids, we need to have a forward looking metric. So you could argue, you know, if we go with a VFM regs as their proposed, you could be stifling investment in illiquids going forward because you're purely looking at backward looking investment performance.  

Mike Ambery: Thanks for joining us today for this episode of Thinking Forward. As always, let us know if there are any other topics you would like us to cover in future episodes, and you can catch up on previous episodes on our website. Just search Standard Life Thinking Forward.