UK pension consolidation is bad news for lower mid-market

With pension pooling, lower mid-market GPs may not see allocations because of size and allocation issues.

Lower mid-market firms and emerging managers could be on the losing end of UK’s pension fund consolidation.

Four years since the UK government’s plan to consolidate 89 local authority pension schemes in England and Wales, eight pools have been created and have started transitioning their assets. The pools have also taken different approaches to invest more actively in private equity.

Yet, the efficiencies of scale that consolidation brings can mean negatives for smaller funds due to a lack of entrepreneurial thinking, according to David Barbour, managing partner of London-based lower mid-market firm FPE Capital.

“It can mean just going after the big funds,” Barbour told Private Equity International.

Local authority pensions have historically been supporters of small funds that fit their own appetite for smaller tickets of between £3 million ($3.6 million; €3.2 million) and £5 million. Merseyside Pension Fund and East Riding of Yorkshire County Council Pension Fund have backed fundraises by Leeds-based Key Capital Partners and London-based Mobeus Equity Partners, according to PEI data. Merseyside committed £4 million to Key Capital Partners’ £80 million, 2015-vintage Fund VII and East Riding made a £5 million commitment to the £166 million, 2016-vintage Mobeus Equity Partners IV.

With pension pooling, the potential losers could be emerging managers and lower mid-market managers who may not see allocations from these larger plans because of size and allocation issues, said Sunaina Sinha, managing partner of London-headquartered placement and advisory firm Cebile Capital.

Other losers may be strategies outside of mainstream buyout, including venture or growth, especially managers with fund sizes that are below £500 million.

The winners will be the larger end of mid-market and large-cap buyouts, often regarded as relatively safe bets for LPs, added Sinha.

There are positives, as consolidation makes the pools of capital more efficient and active in private equity, Sinha noted. “Whereas deployment has been sporadic and driven by smaller consultants to date, a consolidation means that larger cheques can be deployed in more carefully constructed private equity programmes,” she said.

Local Government Pension Scheme Central, which manages about £40 billion of assets for nine pensions in the UK’s Midlands, established its debut private equity vehicle in January and has a near-term plan to deploy more than £2 billion in the asset class.

Other examples include Border to Coast Pensions Partnership, which manages £46 billion on behalf of 12 partner funds including Northumberland County Council and Surrey Pension Fund, which has said it will invest £500 million over the long-term across buyout, special situations, growth and venture strategies. Northern Pool, which manages £44.5 billion in pension assets of West Yorkshire, Greater Manchester and Merseyside, has a £480 million inaugural fund for private equity and is targeting £1 billion in private equity investments by next June.

Brunel Pension Partnership, which brings together approximately £30 billion for eight pensions funds including Dorset, Avon and Cornwall, has created a portfolio of around £200 million confirmed private equity fund commitments. The partnership has a multi-manager operating model, with the discretion to conduct manager searches and commit this money over the next 14 months to a range of funds in line with the portfolio construction plan, Gillian De Candole, investment principal at Brunel, told PEI.

The pools are in various stages of progress boosting allocations to the asset class, with the main objectives to put scale to work and lower costs in order to improve investment returns.

Barbour, whose firm raised £100 million in 2017 for its debut vehicle, noted that for some of the consolidators, the minimum ticket is around £50 million today – a figure too large for smaller funds.

“This counts them [pension pools] out of any lower mid-market fund, plus generally they are often driven by the volume of co-investment they can secure,” Barbour said. No lower mid-market fund would be able to generate very large co-investment sums, he added.

Fundraising for UK-focused vehicles bounced back last year amid political and economic uncertainty around Brexit. Total commitments reached nearly £6 billion, up from £3.9 billion in 2017, according to PEI data. Average fund sizes more than doubled year-on-year to about £450 million.

As funds sizes grow and LPs move to deepen their relationships with existing GPs, smaller funds will need to work harder to access UK pension capital. One positive is that the LP community knows that smaller funds drive more performance, said Barbour.

“There will always be LPs that want to access that, and who will do the work to find interesting specialist small managers.”