Private markets investment

This guidance is for trustees of occupational pension schemes who are considering investing in private markets. It may also be of interest to administering authorities in the Local Government Pension Scheme (LGPS) but does not override statutory guidance on LGPS investments from the Department for Levelling Up, Housing and Communities. The guidance will also be useful for advisers.

Private market assets offer a range of investments including new and innovative opportunities for you to consider in the interests of savers. With the right governance in place, they can play a part in a diversified investment portfolio that aims to deliver improved outcomes and value for money. However, you should take appropriate advice.

If you think greater value could be delivered by investing in a wider range of investment opportunities but your scheme does not have the scale or governance to do so, you should consider whether it would be in members’ best interests to consolidate into a scheme that can provide this. Or you should consider an alternative investment governance model such as fiduciary management.

Published: 24 January 2024

What are private market assets?

Private market assets are investments in the capital of privately owned structures. The main segments of the market are:

• private equity
• private debt
• private real estate
• infrastructure and natural resources

The different segments provide a range of investment stages and opportunities in which investors or funds may choose to invest. Private market investments can offer a broad range of investment opportunities for you to consider, some of which are not available through listed markets.

Private equity

This is when equity investments are held in privately owned companies. They may be held individually or as part of a pooled portfolio of assets. The private equity market, which includes venture capital, currently makes up around two-thirds of all private market investments.

Private equity investment can range from minority investments in start-up or emerging opportunities (venture capital) through to majority or controlling investments in established companies. Venture capital opportunities can offer the potential for high returns but also typically involve higher risk and no income for the investor until the investment is realised. Growth opportunities may arise where operating companies need capital to grow and expand the business. Some of these investments may offer the opportunity for income as well as capital return.

The term of private equity investments will vary depending on the type of investment and the intended exit strategy. They typically could have a seven to 10 year fund cycle though some, particularly venture capital investments, may exit earlier.

Private debt

This is when investors lend directly to borrowers or through portfolios of these investments instead of issuing a bank loan or publicly listed debt. Private debt investments can range from relatively low risk senior debt with lower yields and higher capital security backed by strong lender covenants to high-risk junior debt, distressed debt or venture debt with higher yields and lower capital security.

Private debt can also include asset-based finance bonds that are secured against pools of loans that have similar characteristics, such as:

• residential or commercial mortgages (residential or commercial mortgage-backed securities)
• collateralised corporate loans
• consumer loans

Private real estate

This is when equity or debt investments are made in individual properties or pooled portfolios of these investments and the portfolios are not traded through listed fund structures, such as real estate investment trusts.

Private real estate investment can range from mature operating properties, with established and secure tenants and regular rental income payments, to equity and debt investment in property developments, which require financing through to the operating stage and until the properties are let or sold.

Private infrastructure and natural resources

This is when either equity or debt investments are made in individual infrastructure, natural resource assets or portfolios of these investments.

Private infrastructure investment can range from equity investment in operating assets, with secure cashflows supported by concession agreements, through to equity or debt investment in infrastructure developments.

Natural resources investments, such as agricultural land, forestry and certain commodities, can also involve a wide range of investments with different characteristics.

Illiquid investments

Most private market assets cannot easily or quickly be converted to cash and are therefore often referred to as less liquid or illiquid. The extent to which individual private market assets are illiquid will depend on a range of factors, including the:

• type and nature of the assets
• holding structure of the assets
• economic environment and market conditions at the time
• quality or performance of the assets
• level of demand for the asset in a secondary market

Pension schemes may also hold other types of illiquid investments including:

• hedge funds
• other alternative investments
• specific funds, for example some pooled property funds, some individual investments and small lines of stock that trade infrequently and in small volumes

Some other investments accessed by pension funds, such as hedge funds, involve private companies raising capital from investors, which is then reinvested back into financial instruments, such as equities, bonds or derivatives. In this guidance we have excluded other investments that have a ‘private’ holding structure but invest mainly in listed financial instruments.

Productive finance assets

Productive finance does not have a formal legal definition. However, it is often described as investment that expands productive capacity, furthers growth and can make an important contribution to the real economy. Examples of productive finance include:

• plant and equipment, which can help businesses achieve scale
• research and development, which improves the knowledge economy
• technologies, for example green technology
• infrastructure
• private equity related to these sectors

You can invest in productive finance through a number of asset classes, including:

• equity (including private equity)
• bonds (including private debt)
• real assets (including private real estate and private infrastructure)

You can make productive finance investments through the same asset classes as private market investments. They may provide opportunities to invest in UK business, support economic growth and development, and improve saver outcomes.

Productive finance investments can also offer a broad range of investment opportunities and emerging opportunities for you to consider. Some of these are not available through listed markets, and include, for example:

• the Life Sciences Investment Programme, which aims to provide growth equity finance to high-potential UK life sciences companies
• the Long-Term Investment for Technology and Science (LIFTS) scheme, which aims to establish new investment vehicles for institutional investors and DC pension funds to invest in the UK’s most innovative science and technology companies
• the British Business Bank (BBB), which is working with industry to develop an investment vehicle, the Growth Fund, that will enable third-party capital, including pension fund investment, to gain market access alongside the bank to a range of high growth companies

You should consider the full range of public and private opportunities available, taking account of concentration risks and the impact on overall diversification. You should seek appropriate advice and make decisions that are in the best interests of members.

Accessing private markets

You can access private market assets in different ways, including through:

• closed or open-ended limited partnership arrangements
• regulated funds and collective investment vehicles
• pooled funds offered by investment service providers, for example fiduciary managers
• fund of funds
• co-investments or direct investments

You can sometimes access private assets by investing in public fund structures that only invest in private assets. However, the investment characteristics of these types of investments can be very different to pure private market structures.

You will need to consider the most appropriate way for your scheme to gain access to private market assets. This should include considering market developments and new fund structures, such as long-term asset funds. You should look at a range of factors, including:

• investment opportunity
• ease of access (and exit)
• cost and transparency of fee structures
• governance requirements
• platform availability
• operational issues such as cashflows, valuation and pricing

You will need to take appropriate advice on implementing the investment and how suitable it is for your scheme’s investment strategy.

Secondary markets

Investors can buy and sell existing fund commitments in the secondary market. This market enables existing investors to liquidate their interests, provides the private market fund manager with continued access to the original capital and offers new investors access to the fund.

The range of opportunities in the secondary market can vary substantially and you should carry out detailed due diligence. You will need to be aware of any potential conflicts of interest that might impact transactions.

The motives for investors selling their interests can vary. For example, to:

• reduce longer term exposure to certain sectors or regions following a change in their long-term investment strategy
• move quickly to take advantage of new market opportunities
• reduce overweight positions that may have arisen following material market falls in other assets that the scheme holds: for example, following material improvements in funding levels some DB schemes are much closer to being able to buy out their liabilities with an insurer and want to re-profile their investments with ‘insurer friendly’ liquid assets

Also, fund managers that are under pressure to sell investments as they approach the end of their fund’s life may use the secondary market to delay exiting the underlying assets. This can enable existing investors that want to liquidate their investment to exit, new investors to join and the fund manager to delay asset sales, for example until market conditions improve.

The advantages of buying interests in existing funds include the following.

• Portfolio visibility – the investors are buying into an existing portfolio of assets, rather than a ‘blind pool’ of assets where the assets have yet to be identified and purchased. However, where the original investors’ commitment has not been fully drawn down, the new investor will take on that future funding commitment and will have some ‘blind pool’ exposure.
• Improved return profile – as the investor will be joining at a later stage in the fund’s life, they are likely to avoid the initial costs that the fund incurs as these will be offset by growth in the initial asset portfolio and any discounts on the fund valuation at the point of acquisition. The investor may also benefit from earlier distributions of income from the assets acquired.
• Portfolio diversification – some secondary funds may offer access to investments across a range of sectors, regions, fund managers and vintage years. This can offer investors a smoothed risk/return profile and limit the wide dispersion of returns that might be experienced through investment in individual funds.
• ‘Immediate’ deployment of capital – for secondary transactions the incoming investor’s commitment can be drawn down in part (where the original investor’s commitment is not fully drawn down) or in full immediately. This means the incoming investor can get the portfolio investment benefits (for example, risk, return, diversification) of that allocation immediately rather than having to wait for the investments to be built up by the fund manager over a number of years.

Key differences between public and private market investments

It is important that you understand these differences and also how a mix of public and private assets could complement each other and be used to build a balanced investment portfolio for your scheme.

Investment profile

When investments in public markets are made, the investor’s capital is drawn down immediately and fully invested. The investment will immediately start to generate a capital return. Where the investment is made into a portfolio of public markets investments, it may also start to generate and distribute some income immediately.

Many investments in private market assets are made through closed-ended fund structures, where the investment is drawn down and invested over a period of time, commonly referred to as the commitment period. This is typically three to four years but may be longer for some specific funds. This gives rise to three effects which you should be aware of.

1. You may be under-invested in private market assets compared to your strategic asset allocation for a period of time.
2. Fees are often charged on the level of committed capital, rather than the level of invested capital. However, sometimes the rate charged on invested capital is different (higher) than the rate charge on capital that is still to be invested.
3. Fees are charged before investment and the realisation of any returns following disposal of any assets or any income being distributed from the fund’s portfolio of investments. As a result, investors in closed-ended funds tend to experience negative returns in the early years of a fund’s life. As investments are made and the portfolio of assets is developed, the net asset value of the fund grows and distributions, from income and asset realisations, are made. This profile of negative initial returns followed by a period of increasing returns is typically referred to as the ‘J-curve’ pattern of returns.

The shape of the J-curve is affected by many different factors and will vary between different fund strategies, market environments and fund managers. For example, the J-curve is likely to be significantly shorter where the fund manager can invest the capital and can distribute income from those investments or exit some of them relatively quickly.

With support from your advisers and fund managers, you can look to mitigate both your under-investment in private markets relative to your strategic allocation and the impact of the J-curve through investing in secondary funds, which already have portfolios of assets and are closer to the fund realisation phase. You can also construct portfolios of private market fund investments across different strategies and over different vintage years.

Cashflows and liquidity

The timing and amount of cashflows for portfolios of public market investments can generally be predicted with a high degree of accuracy. Predicting the timing and amount of cashflows for private market portfolios can be challenging. Managers can request committed capital to be transferred at short notice and generally need to be met within a short period of time. You will need to balance the requirements of having liquid assets available against the potential for cash or performance drag on the overall performance of your scheme’s assets. For private market investments, with support from your advisers, you should:

• model (and monitor) the capital calls and distributions you expect to arise across your private market investments
• consider what other cash funding requirements might arise from other assets, for example leveraged liability driven investment (LDI) positions or margin calls on derivative exposures and also from member movements, for example where members or groups of members transfer out or take cash on retirement
• stress test the cashflow requirements, for example by lagging distributions (income or realisations), accelerating capital calls and allowing for the impact of adverse market conditions, including adverse currency movements
• consider what contingent actions might be available to you, for example your scheme employer may be able to provide short-term funding facilities while some scheme investment positions are being realised
• consider how distributions might be used to either rebalance against your scheme’s strategic asset allocation or part fund future expected capital calls

You should also review with your advisers how some of the impact on cashflows might be mitigated. For example, this could be by holding a portfolio of private market assets, spread across multiple types of funds, strategies and vintage years with capital and income on a rolling basis.

Valuation

Publicly listed investments (with a few individual issue, fund and market segment exceptions) can be easily valued and traded. Private market investments are valued less frequently, for example monthly or quarterly. The way they are valued may involve some approximations and simplifying assumptions and may vary between fund managers.

You should understand the approach your fund managers adopt for valuing private market assets and the sensitivity of those valuations to key assumptions or valuation model methodologies used. For example, some managers may consider the value of similar types of public market assets to attribute values to their private market assets. Some may also carry out a full discounted cashflow valuation for each asset. Managers may also vary the valuation methodology they use over the reporting year, for example using more approximate methods at month or quarter end and a more detailed approach at year end. In practice, the actual value of the asset is not known until the asset is sold.

Volatility

As public market investments are generally easy to trade, valuations react to market information more quickly than private market valuations do, so they exhibit much higher volatility. However, while private market volatility may be dampened by off-market valuations, the actual volatility could be similar or higher before costs if the private market asset needs to be sold earlier than intended.

Disclosure

Public companies are typically subject to more regulation, disclosure (including environmental, social and governance (ESG) and sustainability) and performance reporting requirements so there is more readily available, public information. This can make it easier for investors to assess the investment prospects of a public company. However, it may also erode any additional competitive advantage one investor might have over another, as market prices often move quickly in response to newly available public information.

Information on potential private market investments can be more challenging to access. However, some experts can complete detailed research on private market investments and gain an information advantage over less informed investors.

Costs

The costs of investing in private market investments are typically higher than those of investing in public markets. However, the benefits after costs may be much higher from investing in some private market investments over some market cycles. The increased costs can be due to a range of factors, including:

• costs associated with completing increased due diligence on individual investments
• contractual terms around the investment, including around any fund structures
• costs associated with managing the investment on an ongoing basis

You should also be aware that some of the additional costs that arise explicitly in relation to private market assets, for example structuring and legal costs, are already reflected in the price of public equivalents.

Investing in private markets: opportunities and risks

Opportunities

You may decide to invest in private markets for a range of reasons, including the following.

Potential for higher expected risk-adjusted returns

Private market investment offers you the opportunity to access additional returns that may not be available in public markets. The source of these additional returns can vary between private market segments. They can vary from high returns on venture capital investments (where the risk may be rewarded), incremental returns and improved security on private credit investment, through to inflation plus returns on some infrastructure and natural resources.

Access to new opportunities

The range of investment opportunities in private markets has expanded significantly over recent years. Private market investments can offer the opportunity to invest in assets that are not available in the public markets, for example where you can gain access to new and emerging industries and opportunities. More generally, there is a wider range of investments including some where there is also an opportunity for you to have more influence over the contractual terms. These new opportunities can enable you to access investments that offer alternative sources of return and different risk and correlation characteristics.

Sources of income

Investment in private opportunities in private credit, some real estate and infrastructure opportunities can enable you to access a much broader range of income sources. Private credit opportunities can also often offer access, for example, to income secured against company cash flows or assets and exposure to floating rate investments that change as rates change and can offer interest rate protection for investors.

Sources of inflation protection

You can use a range of private market investments to access inflation-linked cashflows or secure increased inflation protection. Some infrastructure assets will have inflation linkages through concession agreements, contracts or regulation. Some real estate assets will also benefit from rental terms that adjust with different measures of inflation, for example Consumer Price Index (CPI) or Retail Price Index (RPI). Natural resources, such as farmland and forestry, may offer a hedge against inflation over the long term.

Additional diversification benefits

Investing in private markets can enable you to access a wider range of individual assets, investment strategies and opportunities within broad asset classes that are not available in public markets. These assets can have lower correlations with public market investments, help reduce downside risk and overall scheme volatility, and provide additional diversification benefits. For DC investors, the lower volatility can also help to maintain members’ confidence in scheme outcomes and their commitment to the scheme.

Investment to meet specific objectives

You can use some private market opportunities to meet specific objectives, for example investing in climate solution technologies or natural capital opportunities, or investing for social impact or local community impact.

Risks

Private market assets can offer significant opportunities for investment, but as with all investments they carry risk which you need to assess, monitor and mitigate. These risks include the following.

Illiquidity

In general, private market assets are long term investments accessed via closed-ended structures and can take years to realise for cash. In addition, some assets in open-ended funds which can normally be liquidated over a short time period may be temporarily ‘gated’ or suspended from dealing if many investors seek to exit them at the same time. This is because the illiquidity of the underlying assets may be greater than the normal dealing cycle of the fund in which they are held. If you need to sell a private asset before it reaches maturity, you may need to sell it at a discount to its accurate asset value.

You should take cashflow and liquidity into account when trying to meet member benefit payments. The terms of a private market investment may include provisions allowing the fund manager to extend the life of the fund beyond the initial (for example 10-year) timeframe. The timing of capital distributions from a private assets fund will depend on when the underlying assets are realised, so it is difficult to forecast when the scheme will receive any cashflows produced by the investment. In addition, illiquidity in the investments can introduce challenges when you want to change your scheme’s strategic asset allocation, for example following a significant change in valuation in public markets or after a strategic review.

Some public market assets can also be hard to liquidate, for value, during periods of market stress. You should undertake adequate stress testing on these scenarios to ensure that in times of stress the illiquid portion of the scheme is not too large and the scheme can still pay benefits and meet any demands on cash. Private markets investments therefore need to be part of a well-diversified portfolio so that other assets can meet these needs.

Governance

You will need to ensure that there is appropriate governance in place to enable the effective management and monitoring of private market investments. Governance requirements include:

• obtaining appropriate investment advice through the initial investment selection
• seeking legal advice on the structure and terms of the investment
• addressing operational issues such as meeting investment drawdown requirements, allocating costs, valuing assets, and attributing and monitoring performance
• dealing with performance issues

Dispersion of returns

While, on average, after allowing for costs and fund fee structures, private market assets may outperform public market assets, there can be a wide dispersion of returns across individual assets and funds, within and across strategies and managers. For example, within early-stage venture capital, many small companies fail and only a limited number will produce significant returns for investors. You should be aware of the potential for dispersion of returns between individual funds and in particular between venture capital funds. Portfolios of funds diversified, for example, by industry, sector and vintage year can help you achieve a level of overall portfolio return within a targeted range.

You should set clear objectives for your private market investments and take appropriate advice from your advisers, including on private market portfolio construction.

Your legal duties

When exercising investment powers, the law requires you to act in the best interests of scheme members and beneficiaries.

You are required to ensure that the scheme assets are predominantly invested in investments that are traded on regulated markets and are properly diversified.

If you choose to include assets in the portfolio that are not permitted to trade on regulated markets, you should keep these to a prudent level. Private market assets are in this category as they are not traded on the stock market or a public exchange.

You must also ensure that your powers of investment, and the discretion of any fund manager that you have delegated powers to, are exercised in a manner calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole. You should pay particular attention to liquidity requirements.

The proportion of your scheme invested in private market assets will vary in line with market movements and changes in asset values. You need to regularly monitor the performance of your investments and your scheme risks as part of your scheme’s risk management framework. These risks should include scheme liquidity and cashflow requirements and the potential for regulatory breaches.

Periods of extreme market stress could lead to you having an excessive proportion of your investments in private assets. In such instances, you will need to have a clear strategy and process in place to rebalance the portfolio within a reasonable timeframe.

You should be aware of the legal restrictions relating to employer-related investments and loans (ERI), see our guidance on employer related investments. Employer-related investments held through private market funds can create additional challenges in managing employer-related investment exposures. You should consider this risk, and ways of mitigating it, with the manager and your advisers.

Following recent changes to regulations, trustees of most schemes providing DC benefits are required to disclose and explain:

• their policies on illiquid assets in the default statement of investment principles (SIP) or the scheme SIP for collective DC schemes
• the percentage of assets in the default fund(s) or for the scheme as a whole for a collective DC scheme that are allocated to certain asset classes in their annual chair’s statement

For further information regarding your legal duties, see our DB investment guidance and DC investment guidance pages.

Key considerations when deciding whether to invest

There are a number of matters you need to consider when looking to invest in private markets.

Trustee knowledge and understanding

Private market investments can be more complicated in structure and operation than public investments such as equities and bonds. Trustees of some DB schemes will already be familiar with a range of private market assets, how those opportunities might be accessed and the range of operational and governance issues they introduce. However, many DC scheme trustees will have limited experience of investing in these types of assets. They may have only invested in some pooled property funds and may have less knowledge of how the wider range of private market assets might be accessed by DC schemes.

It is important that your trustee board has the right knowledge and understanding of private markets investments to engage effectively with your advisers, so that you make good decisions and protect members’ interests. You should be mindful that knowledge and information gaps can act as structural barriers to considering private market assets and you should take appropriate advice.

You need to be able to consider the full range of investment opportunities and risks, as this could lead to improved outcomes for members. Review the current skills, experience, backgrounds and knowledge of your existing board, and consider whether further training is needed or whether to change the composition of the board, for example by appointing a professional trustee with experience in investing in these types of assets. For further information about reviewing your board see our scheme management skills guidance.

Governance budget

You should aim to set a governance budget for your scheme. This should allow you to receive an appropriate level of advice and service from your investment service providers and enable you to focus on delivering improved outcomes for members.

You should focus more on the value that investing in these assets can bring, rather than cost, and monitor the performance of your advisers and service providers against the net outcomes delivered. Investing in private markets may increase costs due to increased due diligence and higher fees but can offer the potential to deliver greater returns for members.

Where increased costs are not delivering improved outcomes for your scheme’s members over, for example, three or five-year rolling periods, you should look to understand why, and take action where needed. This could include, for example, replacing advisers or service providers, renegotiating fees and contractual terms, or changing your governance model.

Investment advice

It is your role to decide how to invest scheme assets, but you will need to obtain appropriate investment advice before making a strategic decision to invest in private markets and to implement any investment arrangements.

You will need advisers who have the right skills and the relevant experience to advise you on these types of assets. They should also advise you on the opportunities these assets may offer, the risks they might present and how they might be mitigated, and how they might be accessed. You should ensure that any additional risks to the scheme are considered and recorded in the risk register, and regularly monitored and reviewed.

If your current advisers do not have the right skills and relevant experience to help access and implement the full range of investment opportunities appropriate for your scheme, including private market assets, you may wish to either review your current advisers or consider seeking specialist advice elsewhere to complement your existing arrangements. You may also wish to consider tendering for investment consulting services that better match your objectives and meet the requirements for your scheme. For further information, see our guidance on tendering for investment consultancy services.

You must set objectives for your investment advisers and you may also wish to set specific objectives around private market investments and measure their performance against those objectives. Private market objectives may include:

• trustee training on wider investment opportunities, including private market opportunities
• regular updates on market developments and new investment and fund opportunities
• demonstrating value added through investment recommendations and selection

See our guidance on setting objectives for investment consultants.

Investment requirements and scheme governance

Before deciding whether private market assets might be appropriate for your scheme, you will need to consider with your adviser how you expect your scheme to develop in the future. You should also consider how the assets might be used as part of a diversified portfolio to meet your scheme’s objectives and requirements, for example in relation to expected return, diversification of risk and cashflows. You should consider whether the additional risk that will be taken on, including illiquidity risk, will be adequately compensated for.

The table below provides a high-level illustration of typical characteristics of different types and stages of private market investments, relative to publicly listed investments such as equities and bonds. The table is not exhaustive and private market assets need to be considered as part of a wider portfolio of scheme assets. You should take advice to understand how the individual characteristics of specific private market assets contribute to the overall risk, return and investment characteristics of the total scheme portfolio.

You should also be aware that some of the additional costs that arise explicitly in relation to private market assets, for example structuring and legal costs, are already reflected in the price of listed equivalents.

Table 1: Example characteristics of different types and stages of private market investments

	Potential returns	Expected risk	Income availability	Investment costs	Liquidity
Private equity – venture capital	Very high	Very high	Nil	High	Very low
Private equity – buy-out	High	High	Limited	High	Very low
Private debt – venture	High	Very high	Limited	High	Very low
Private debt – senior	Medium	Low-medium	High	High	Low
Real estate – opportunistic	High	High	Limited	High	Very low
Real estate – core	Medium	Low-medium	Medium	Medium	Low
Infrastructure and natural capital – opportunistic	High	High	Limited	High	Very low
Infrastructure and natural capital – core	Low-medium	Low-medium	Medium	High	Low
Listed equities	Medium-high	High	Medium	Low-medium	High
Listed bonds	Low-medium	Low-medium	Medium-high	Low	High

If you conclude that investment in some types of private market assets may meet your investment requirements, for example in relation to expected return after costs, you will also need to understand how key features of these types of investments might impact on your scheme’s governance, administration and operations. You should consider the following.

• What the (net) cashflow position and liquidity requirements of the scheme are likely to be over future periods (short, medium and long term).
• What the cashflow profile of the private market investment might be. For example, some private market investments will draw down capital committed by investors as assets are sourced or developed, some may not generate any income return for five to six years and some may only ever deliver a capital return.
• What the redemption terms are, how and when the investment is expected to be exited, and on what terms.
• What the provisions are for the fund life to be extended and in what circumstances they can be triggered.
• What provisions govern the establishment of a successor fund or the rollover of the original fund and how conflicts of interests around the successor fund are managed, for example in relation to valuation of the assets or the set-up costs for the successor vehicle, or payment of the fund investors' performance-related fees.
• How the fund fees might be structured, including how and when performance fees might arise and how they might impact individual members.
• How the assets are valued, how frequently and on what basis. For example, some private market assets may only be subject to full valuations once a year, with interim valuation updates being done on an approximate roll forward basis, using wider market investment returns rather than specific returns relating to the individual assets held.
• How performance of the private market assets will be reported and when.
• How investments (or units in a collective investment vehicle) might be priced, on what basis and how frequently.
• How liquid the underlying assets are and when the assets could be realised for cash (if needed) and on what basis (for example, through a secondary market sale).
• How a DC scheme might incorporate illiquid assets by managing overall liquidity at the default strategy level.

You should also consider how private market investments might be impacted by structural changes to the scheme, within the scheme or affecting the scheme, for example if:

• the trustees of a DB scheme decided to transfer a material part, or all, of their scheme’s liabilities to an insurer or consolidation vehicle
• a DB scheme’s employer weakened materially or became insolvent and the scheme’s investment risk appetite materially reduced
• there was a bulk transfer of DC members following a sale of part of the employer’s business
• an employer decided to move from one DC master trust provider to another, following a period of poor service or a sustained period of investment underperformance

Once you decide to invest in a specific fund or private market investment opportunity, you will need to understand its key features and contractual terms. You should work with your advisers and engage with the fund provider to ensure the features, terms and fund reporting requirements can better meet the needs of your scheme.

Private market assets are likely to require additional board time to review advice, opportunities and risks. It is therefore important that you have the right governance structure and access to the right type of investment service providers to consider these types of investments and implement them if you think they will lead to better outcomes for members.

Having the right investment governance model is important to ensure you can make timely investment decisions, access appropriate advice and implement your investment strategy efficiently. If your current governance model limits your ability to consider the full range of investment opportunities, including private market assets, you should consider reviewing your investment governance model. See our guidance on choosing an investment governance model.

Liquidity risk management

We consider that trustees of all schemes could benefit from developing a liquidity risk management plan for their scheme. The plan should examine liquidity needs in benign circumstances and under market stress. It should allow fully for the assets held which are valued on a mark-to-market basis using market prices and the assets held which are valued on a mark-to-model basis, where the pricing may be inaccurate, particularly if the investments have to be realised sooner than expected. Where the investment or interests held can be transferred to other investors in the fund, the plan should allow for the costs that might be incurred and the asset valuations that might realistically be achieved on transfer.

The dynamics of individual scheme cashflows are unique and can vary with the fortunes of their employer and the scheme’s investment arrangements. Therefore, trustees of some schemes could benefit from including additional scenario and sensitivity analysis in their liquidity risk management plan on potential future scheme changes. This may be the case if, for example:

• the DB scheme employer decides it wants to remove the legacy DB liabilities from its balance sheet earlier and transfer the liabilities to an insurer or consolidator
• the DB scheme employer becomes insolvent causing a significant reduction in the trustees’ risk appetite
• the DC scheme employer goes through a corporate transaction and a large portion of the employees (and scheme members) move to a new scheme as part of that transaction
• a DC master trust loses a participating employer, which has a material impact on the membership profile
• a DC scheme or master trust decides to consolidate or exit the market

Trustees of DB schemes that use leveraged LDI can find further information on liquidity requirements in our LDI guidance.

Performance fees

The fees for managing private market investments are typically higher than the fees on public market investments but may have a positive net impact on the value delivered. This reflects a number of factors including, for example:

• higher levels of active management combined with more specialist knowledge of sectors, assets, industries and geographies
• use of more concentrated investment portfolios
• additional costs, such as deal sourcing and acquisition costs
• the different skill sets involved

Performance-related fees are often a feature of private market fund investments. These are sometimes referred to in documentation as ‘carried interest’. While performance-related fees may be very helpful to ensure the interests of the investment manager and the investor are aligned, it is very important that you fully understand how the performance fee operates and take appropriate advice.

To remove a perceived barrier, the Department for Work and Pensions (DWP) introduced changes to regulations that now allow trustees of DC schemes to exclude specified performance-based fees, which covers both fees and payments made under profit-sharing arrangements, from the charge cap if they meet specific criteria. For further information see our DC investment governance guidance.

The DWP has published statutory guidance which highlights features of well-designed performance-related fee structures. Before you invest in any fund with a performance-related fee structure, you should also consider asking the investment manager or your investment adviser to produce some illustrations of how the performance fee would operate in practice, for your intended level of investment, and for different levels of investment performance.

This type of analysis can help you to understand whether the performance-related fee structures might:

• encourage the investment manager to take excessive risk, for example where the performance fee is not capped
• reward the investment manager excessively for poor performance or relatively low levels of outperformance
• allow excessive levels of performance fees to be paid to the investment manager before all of the fund investments have been realised for value
• poorly align interest between the investment manager and the trustee
• unfairly attribute performance fees across different member cohorts

Performance-related fee payments can be very material for some funds. Those levels of payment may be appropriate under a well-designed performance-related fee structure, particularly where the interests of the manager are properly aligned with yours. However, the detail of the performance fee structure is crucial and you need to ensure you have a full understanding of all the features of the structure before you commit to the fund. In DC schemes, this arrangement could impact differently on member cohorts in the default strategy. For further information see the 'Treating members fairly' section.

Public market alternatives

Some schemes have holdings of public assets such as investment trusts, real estate investment trusts or baskets of public companies with underlying exposure to property, infrastructure or private equity. These investments are quoted and priced daily so present fewer operational issues when included in a scheme’s asset allocation but will typically include an element of equity market risk. These public market alternatives may therefore provide a reduced level of diversification benefit when compared to direct investment in private market assets. In some examples, exposure may be to the equity of asset managers operating in the sector rather than to the underlying assets.

Where the public vehicle is an investment trust, the value of the underlying assets may be priced at either a discount or a premium to their net asset value, depending on current market sentiment, general supply and demand for the investments and individual features of specific investment trusts. Values can also be strongly correlated to equity markets in the short term, rather than to the net asset value of the underlying investments.

You should ensure that allocations of this type fulfil their role in terms of investment return and diversification benefits.

Member communications

Many private market assets that you may invest in can be hard, physical assets that are more tangible to members, for example infrastructure or forestry assets. Some private market investments can also be made around specific themes that may resonate with scheme members and capture their attention, for example climate change or ESG, or investment in hard physical assets in the UK. Therefore, investing in private market assets may create additional opportunities for you to engage with your members.

Trustees of DC schemes also need to ensure that members understand the impact that investments in private market assets, in the scheme default or in any self-select funds, might have on their decisions to transfer away from the scheme, or retire earlier than expected or take their retirement benefits in a different form. You should ensure that you manage member expectations on the liquidity and potential realisation of these investments and it is made clear to members that there may be times when the fund has to be closed for withdrawals.

Specific DB matters to consider

Trustees of many DB schemes have invested material amounts of their scheme assets across a range of private market investments and other illiquid assets over many years. The types of private market investments and strategies they invested in were based on their objectives for those investments, for example in terms of expected return, cashflow generation, and diversification at that time.

As the liabilities of most DB pension schemes have matured, average funding levels have improved and regulatory expectations have changed. The role that trustees now require their private market investments to play within their scheme’s investment strategies has changed along with their capacity to invest in these assets. For example, as schemes have become more mature and growth allocations have reduced, private market assets producing secure income and inflation-linked cashflows have increasingly been incorporated into schemes' liability-matching allocations.

It is a requirement that the assets held to cover the scheme's technical provisions must be invested in a manner appropriate to the nature and duration of the expected future benefits payable under the scheme. You must also consult with the employer before preparing or revising your scheme’s statement of investment principles and obtain appropriate written advice. Your capacity to invest in certain asset classes is influenced by a number of key factors, including the:

• maturity of the pension scheme
• longer-term objectives for the scheme
• level of scheme funding (and the funding basis)
• strength of the employer covenant
• scheme employer’s objective for the scheme

In practice, the characteristics of private market investment opportunities vary significantly across and within private market categories. When considering whether to invest in individual private market investments, you need to consider how the investment characteristics meet your investment objectives and whether some characteristics might create challenges for your scheme, for example the lack of cashflows.

Different schemes with the same status (for example closed) will have different levels of funding and employer support and will have different return targets and objectives. Depending on your circumstances, these factors will influence your capacity and willingness to invest in some private market investments. Some examples are as follows.

• A closed scheme that is 75% funded on a buy-out basis may look to target a higher allocation to growth assets than a closed scheme that is 95% funded on a buy-out basis, with a similar employer covenant. This could include some private market investments that might be expected to deliver a higher (net) return over market cycles.
• A scheme which is funded above buy-out may look to use private market investments as part of a strategy to generate surplus.
• An open, immature scheme with a strong employer may have considerable capacity to invest in private market assets.
• Where a scheme has a particularly weak covenant and the risk of employer insolvency is high, the appetite to invest in illiquid assets may be limited. This is particularly if those assets are likely to need to be sold at a discount as part of the longer-term solution for the scheme, following the employer’s insolvency. Trustees should review the range of longer-term options that might be available for their scheme (for example insurer buy-out, superfund transfer, alternative funding structures) and consider their likely requirements as part of any transaction.
• A mature or super mature scheme that is expected to buy out its liabilities with an insurer within three to five years is unlikely to want to hold any private market assets without fully understanding the appetite for insurers to take them on.

Table 2 provides a high-level illustration of the potential appetite that schemes of different status (open, closed, etc) with different maturity profiles might have for illiquid assets, including private market investments. The table also provides a high-level illustration of the categories of private market assets that might be more suitable for average schemes of different maturities.

Table 2: Illustration of potential DB scheme appetite for different types of private market investments

Scheme Status	Maturity	Objective	Potential appetite for illiquids	Private equity	Private credit	Private real estate	Infrastructure and natural capital
Open	Immature	Run-on	High	High	Medium	High	High
Closed with accrual	Immature	Run-on (circa 15 years)	Medium	Medium	Medium	High	High
Closed with accrual	Mature	Insure (5 years+)	Very low		High
Closed with accrual	Mature	Consolidate	Low	Low	High	Low	Low
Closed	Mature	Insure (5 years+)	Very low		High
Closed	Mature	Consolidate	Low	Low	High	Low	Low
Closed	Mature	Run-on to generate surplus	Medium	Medium	Medium	Medium	Medium

Specific DC matters to consider

Many DC schemes, particularly master trusts and some large single employer schemes, have strong positive cashflow and a high proportion of members invested with a long time horizon. This offers an opportunity for those members to benefit from the illiquidity premium available from private assets and to invest in opportunities that can enhance returns over the long term.

Most DC investment strategies to date have been concentrated in highly liquid public investments. The funds in which these assets are held and the platforms that support these DC funds typically offer daily pricing and liquidity as standard. Given the long-term nature of pension fund investment and the positive cashflow position of many schemes, the actual need for daily liquidity is often far lower than current investment strategies provide for.

Trustees of DC schemes may wish to review their current investment strategies with their advisers to determine whether the addition of certain private market assets to their investment portfolios could help deliver better outcomes for their members at retirement and beyond.

Value for money

The proposed value for money framework seeks to shift the focus from an over reliance on cost to a more holistic emphasis on long-term value, highlighting the investment return delivered to members, net of fees and charges. Private market investment generally carries higher costs than investment in public markets but may have a positive net impact on the value delivered, improving outcomes over member lifetimes.

Investing a proportion of the default strategy in private markets could help you to achieve better outcomes over time through additional returns after fees and increased diversification. This could lead to lower volatility in overall returns. Certain private market investments, for example environmental projects and green energy technologies, may also provide greater opportunity to align with member interests. In addition, returns from some infrastructure investments may provide future cash-flows linked to CPI, providing useful inflation-linking to members’ investments and increasing the predictability of potential outcomes in real terms.

Investment platforms and private market fund structures

Many private market investments have features that differ from quoted market investments such as equities and bonds. They may have different legal structures or be incorporated in other jurisdictions, and many are not valued or priced daily. This may impact on the operation of the default strategy.

Not all investment platforms currently have the capabilities needed to include these assets although this may change as demand for private assets increases. You will need to ensure that the platform on which your scheme operates can incorporate illiquid private market investments into an overall solution for your scheme’s strategy.

There are several routes through which DC pension schemes could access less liquid assets. The guide investing in less liquid assets: key considerations, published by the Productive Finance Working Group, sets out key features of the three types of open-ended structures that are likely to be most relevant to DC schemes:

• long term asset funds (LTAF)
• professional open-ended investment funds
• unit-linked life policies

Some other funds that are structured as Non UCITS Retail Schemes and operate as Funds of Alternative Investment Funds (NURS-FAIFs) can also invest in less liquid assets. These are FCA regulated funds which may be used by a wide range of investors including DC schemes. However, the LTAF structure, which was designed with the default arrangements of DC pension schemes largely in mind, is expected to be more widely used for these type of less liquid asset investments.

The section in the guide titled ‘Guide to the fund structures to access less liquid assets’ sets out key features of these individual options.

The section titled ‘Legal Guide to the Long Term Asset Fund (LTAF)’ provides a brief overview of the key features of the LTAF, including an explanation of the LTAF’s legal structure and a summary of key terms.

Apart from a number of property funds, insurance-based platforms will typically only provide access to private market investments through the above structures. Where you hold assets directly (with a custodian), there will generally be fewer restrictions.

You should obtain appropriate advice on the practicalities of including private market investments and discuss any additional requirements with your platform provider or custodian.

Future consolidation

You will need to seek the views of the sponsoring employer, or the scheme funder/strategist in the case of a master trust, on the long-term future of the scheme before making any illiquid private market allocations.

If there are plans to consolidate the scheme in the future, you will need to consider whether the receiving scheme is able to accept a transfer of illiquid assets. For example, the master trust may operate on a different investment platform which is unable to receive a transfer of illiquid assets. In this case, you could either be prevented from consolidating or might need to find a buyer for the illiquid assets on the secondary market, which could result in a significant loss of value for members. It is important to consider any potential future scheme changes before making any investment.

Funding of commitments

Closed-ended private market investments are often funded over several years. Investors make a commitment to the fund manager at the outset, but the committed funds will be ‘called’ or drawn down gradually as underlying investments are identified or as projects are developed. Calls for cash from the fund manager may arrive at short notice so you will need to consider with your advisers where to invest any undrawn commitment during this period.

You may consider it appropriate to hold undrawn commitments in an asset class with similar risk characteristics. For example, in the case of a commitment to a private equity fund, the undrawn allocation could be held in quoted equities during the draw-down period. Holding a large amount of cash during a member’s growth phase could be detrimental to the outcome they receive at retirement, but you will need to ensure any interim allocations are sufficiently liquid to meet potential capital calls.

Commitments to funds are made in nominal (for example £ million or $ million) terms. You should consider how those commitments might be fully funded if the assets held to fund those commitments fell in value or were affected by changes in exchange rates. This could include over-allocating to the interim allocation and/or identifying alternative investment sources within your scheme assets, from which those commitments might be funded.

De-risking and decumulation

Where the asset allocation of the default strategy changes over time, for example in target date or lifestyle strategies in the de-risking phase of the pre-retirement period, particular attention needs to be given to the liquidity characteristics of the underlying investments. You will need to understand the specific liquidity and pricing features of any private market investments and the capabilities of the investment platform to ensure that the member journey plan is not adversely impacted. This will require forecasts and analysis of future cashflows in and out of the default strategy and working with your platform provider and advisers to ensure the smooth operation of the default asset allocation over time. You will also need to consider the potential for members making ad-hoc withdrawals.

Similarly, where a scheme offers a post-retirement drawdown strategy, certain private assets can generate cashflows which are helpful in meeting member income requirements. The liquidity of any private market investments used for this purpose will need to be taken into account to ensure the allocation to those investments remains proportionate over time and does not materially impact the member risk profile.

DC scheme investing involves investing over long timeframes. The potential for schemes to take on investment risk and the level of investment risk that they might take on over those timeframes varies. You should consider how you might use different types of private markets investment at different parts of member lifestyle strategies to generate improved member outcomes.

Treating members fairly

The returns from private market investments may not reflect the anticipated performance of the underlying assets during certain parts of their investment cycle.

Where investment is made in a closed-ended fund with a long-term (10 years or more) prospective timeframe, returns in the early years may be lower than in later years, and may be negative during the early period. For example, when investing in a closed-ended infrastructure fund, there may be an initial construction or commissioning phase in the underlying projects. During this period, the project assets may not be operating and no revenues will be generated. It is only as projects come to fruition and start to earn revenues that positive returns will start to accrue. Investing in a diversified range of opportunities at different phases of their investment cycle may help to mitigate this.

Interim valuations of private market investments may not accurately reflect the underlying asset value at that time as they may be estimates using modelling techniques or quoted market proxies for reference. Any differences between actual and estimated values may vary over time and this may favour one cohort of members over another.

The fees charged by the fund may also be based on the entire commitment, rather than the amount of capital which has been drawn down and invested in the project to date. You should consider the impact this may have on different member cohorts joining or leaving the default strategy over the life of the investment and seek ways to mitigate any imbalance between members.

Where performance-related fees are charged within private market investments, these may be subject to high watermark provisions. These provisions are important to ensure that fluctuations in the returns from the investments over time do not result in performance fees being taken twice by the manager or provider.

This type of arrangement may impact differently on some members of the same default strategy, depending on when they invest contributions or withdraw funds. You should be aware of this impact. You should discuss with your advisers and take appropriate advice on how any detrimental impact on individual members of the scheme might be mitigated or minimised. This might be through the design of the performance fee structures, including the performance smoothing and the mix of fee arrangements used across the scheme’s portfolio of private market investments.

Find an example of the operation of a high watermark in the DWP’s ‘Disclose and explain asset allocation reporting and performance-based fees and the charge cap’ statutory guidance.

Liquidity management

Where illiquid private market investments are incorporated into a scheme’s asset allocation, you will need to ensure they do not impact on the ongoing operation of the default strategy. This may involve forecasting future long-term cashflows, stress testing of any proposed allocations and completing scenario analyses, taking in any known risks to the allocation and the scheme as a whole. For multi-employer schemes such as master trusts, the risk of a large employer or group of employers leaving the scheme should also be factored into any stress testing scenarios. If you offer daily pricing and trading for members you will need to consider the potential mismatch between prices and liquidity offered to savers and that of the underlying assets.

In times of market stress, there may be periods when dealing in certain open-ended private market investments such as direct property funds is suspended for a substantial period, making it impossible to move money in and out of the fund. This may impact on the operation of the default strategy or any affected self-select fund. It is important that the default arrangement can still accept inflows and outflows and so contingency needs to be built into the default strategy to account for this.

You need to work with your investment platform and advisers to ensure that measures are in place to minimise any impact that suspension of an underlying fund may have on the scheme and on any members who are affected. For example, this may mean identifying another fund into which contributions may be paid during any suspension, or having arrangements in place to fund any withdrawals during the period from elsewhere in the asset allocation. Find further guidance on the temporary closure of funds in the default arrangement in our DC investment guidance.

You may wish to seek appropriate advice and to discuss any potential issues with your platform provider to ensure that any identified risks are minimised.

Valuations

Valuing some private market investments can be challenging. The actual market value of an illiquid asset can only be established on sale. However, you will need to obtain estimated valuations at various dates, as members join, leave, die, or transfer to other options within the scheme or externally so you are able to settle members' accounts, offer valuations and allocate fees and investment performance to member accounts. It is therefore important to understand the frequency of valuations, the credibility of the valuations and how they are used. You should do the following.

• Ensure that rigorous valuation governance processes are in place and the proposed valuation date points meet the administration requirements for your scheme.
• Obtain appropriate advice from your investment adviser, legal adviser and scheme auditor.
• Understand the difference between pricing approaches and in which circumstances different approaches may be acceptable or necessary. For example, the use of stale prices (where prices from an earlier date are used), or the use of modelled prices (where current prices are estimated based on previous prices but are updated for market developments).
• Analyse member movement scenarios to understand the practical implications on valuations, allocation of fees, performance and liquidity requirements.
• Analyse downside valuation scenarios to understand the operational issues that would arise in stressed markets or when invested assets are subject to, for example, an audit qualification.
• Recognise that prices may not be immediately available on the date of dealing, as there may be a lengthy valuation process.

Market developments

The DC market is relatively immature and until recently has invested less in private markets than the DB market. This was driven in part by:

• lack of individual DC scheme asset scale
• complexity of investing in these types of assets
• lack of sufficient scope within scheme governance budgets
• wider industry focus on inputs (costs) rather than outputs (saver outcomes)

However, following the progress made by the Productive Finance Working Group and other recent regulatory and industry developments, innovation in investment and risk management is starting to flow through to the DC market.

These developments will widen the range of investment and risk management opportunities available and may enable you to improve member outcomes. You should monitor these developments and ensure that your advisers keep you fully informed of emerging opportunities. If you decide to invest in some of these emerging opportunities, as with any investment, you should obtain appropriate advice for your scheme including on the suitability of the investment and the investment provider.

Some DC master trusts and single employer DC schemes are expected to gain considerable scale in the short to medium term. As your DC scheme gains scale, in addition to considering a wider range of investment and risk management opportunities, you should also consider whether your scheme governance and investment management structures remain fit for purpose.

Additional resources

Productive Finance Working Group (PFWG)

The Bank of England, Financial Conduct Authority and HM Treasury set up this industry working group in 2020 to develop practical solutions to addressing the barriers to investing in less liquid assets.

Following the first phase of their work, the PFWG published a roadmap for increasing productive finance investment in September 2021.

Following the second phase of their work, the PFWG published a series of guides in November 2022 to help pension schemes understand risks and opportunities of investing in illiquid assets. This series of guides, which are not regulatory guidance, was prepared by industry for industry. They may be of particular interest to trustees of DC schemes and includes guides on:

• value for money and less liquid assets
• performance fees in less liquid assets
• liquidity management
• fund structures to access less liquid assets
• long-term asset funds

DWP statutory guidance

In January 2023, the DWP published its response to its consultation on broadening the investment opportunities of DC pension schemes together with statutory guidance for trustees on disclose and explain asset allocation reporting and performance-based fees and the charge cap. Read the consultation response and statutory guidance on GOV.UK.

Case studies on investment in illiquid assets

The Pensions and Lifetime Savings Association report Pension Scheme Investment in Illiquid Assets sets out case studies from ten schemes, including some Local Government Pension Schemes (LGPS). It aims to provide decision makers with information on how pension schemes invest in this asset category and the issues to consider when making these commitments.

The report outlines how different pension schemes are investing in a wide range of illiquid assets including commercial property, infrastructure, housing and in private markets. It details the benefits and specific risks identified by those schemes.

The report also includes an additional perspective from an investment manager whose funds are used by their own master trust.

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