This article is sponsored by eFront.
How would you describe pension plans’ appetites for private markets today?
The appetite for private market asset classes has grown extensively across the institutional investor landscape, particularly in the pension plan community. That is partly driven by performance – research shows that private markets have outperformed public markets historically.
Naturally, pension funds want to participate, diversify and have an expanding role in the private markets. While many pension funds are primarily pursuing indirect investments, there is also a marked increase in the number of pension funds that are becoming more sophisticated in their ability to execute on co-investments, which offer tangible benefits both in terms of economics and direct access to the companies themselves.
How does appetite differ across asset classes and geographies?
Most pension funds remain keen on private equity, and that is where the bulk of exposure lies. Yet, we have also seen continued interest in real estate and a significant increase in appetite for private credit. US and Canadian pension plans have always been big investors in private markets. However, we are now seeing growing appetite from Europe, especially the UK. Most UK pension plans have been cautious about expanding their private markets exposure beyond the 20 percent cap that was meant to be enforced this year. Now that the cap is not going ahead as expected, UK pension plans are free to expand their private markets book of business, opening up further investment opportunities in the alternatives space.
Now that UK pension plans are free to increase their private markets exposure, what operational challenges does that present?
There is so much demand from these UK pension funds that it creates a highly competitive environment. There is a real first-mover advantage for pension plans that are ready with the technology and data capabilities required to make sense of the complex and disparate data sources in private markets. Historically, data gathering has been an error-prone and inefficient manual process. The information available has been the bare minimum required to manage investments, compared with the public markets, which are much more transparent.
To effectively minimise the risk and maximise the opportunity associated with investing in private markets, investors first need to work with fund managers to access the necessary data and make sense of it. That means radically overhauling their operations, including team structure and team size. Pension fund investors need to build proper middle- and back-office functions to manage capital calls and distributions and understand where the risks and opportunities lie. Those operational complexities also create the need for better technology; technology budgets will likely need to be increased if pension funds are looking to reach their full private markets potential.
What challenges does an increased focus on ESG present for pension plans entering or scaling up in the alternatives space?
There is a tremendous amount of attention being placed on ESG at the moment. That puts a lot of pressure on investors, which need to demonstrate their sustainability credentials. In fact, the diversification advantage that private markets offer includes the ability to meet certain objectives, such as sustainability goals. However, diversification does inherently increase the operational burden on the investors.
Again, investors need to be able to access the necessary sustainability data, just as they need to access data from a performance perspective. They then face the challenge of looking at that data across both private and public markets. A significant amount of sustainability data is available in public markets today, but very little in the private sphere. Investors need to be able to collate all that information in one place to then make sense of it.
Investors also need to be able to collate climate risk data, both in terms of transitional risk and physical risk. Climate risk is a constantly evolving area. Investors need access to those metrics to make assessments and model out what climate risk might look like in the future, especially if a pension fund has made commitments around reaching net zero by a given date, for instance. Pension funds need to understand what investing in a certain fund will mean for those overall sustainability objectives.
We have seen a steady proliferation of regulations around ESG, typically related to compliance reporting. The Sustainable Finance Disclosure Regulation and Task Force on Climate-related Financial Disclosures are particularly prominent in Europe. Regulations like this introduce yet another level of complexity.
What role can technology play in resolving some of these issues?
This shift toward alternatives is a watershed moment for the pension funds industry in terms of how these investors operate. The technology upgrade will help pension funds optimise the process of investing in alternatives and ultimately create efficiencies, cost savings, and better data and reporting in their existing operations. Technology can be a multiplier for everything pensions do, affecting positive change across their entire book of business.
It all comes down to the “three Rs” – risk, regulation and reporting. Having access to comprehensive, high-quality data across both public and private markets is critical to mitigating risk. We offer standardised data on multi-asset portfolios through our platform, from the portfolio level down to the underlying assets. We are also able to provide data on climate risk in public markets and are looking to provide climate risk data on private assets in the future as well.
Sophisticated technology is also essential from a regulatory and compliance point of view, as the regulatory environment continues to evolve. Pension funds not only need to consider sustainability regulations such as SFDR and TCFD, of course; there are also the regulatory requirements around MiFID, as well as existing requirements around operational and performance data.
When it comes to reporting, technology can help make the process as simple, timely and transparent as possible by providing everything from public and private benchmarks to advanced analytical tools to help investors understand what is in their portfolios.
Technology will not answer every question, of course. Relationships are paramount in private markets and will remain critical. However, the right tools can tell you where to direct your energy – where you need to dive deeper and where you need to ask questions of your fund manager, or the underlying business if you are co-investing or investing directly.
Melissa Ferraz is managing director and global head of eFront Insight at BlackRock.