As Nest adds private credit, should platforms ditch daily dealing?

Private credit investments are not traded on a public exchange or market, but are usually directly negotiated loans between an investor (or small group of investors) and the loan’s recipient.

DC investors are severely underweight most of the illiquid markets in which their defined benefit peers have become an established presence, despite long time horizons and evidence of a premium available in exchange for locking up money in real assets.

An audience poll of attendees at the Pensions and Lifetime Savings Association’s annual conference suggested that 76 per cent of DC decision-makers have no exposure to illiquid alternatives other than property. The same proportion of overall DC assets were invested in public equities and bonds in 2016, according to research company Spence Johnson, with “property and other” representing just 5 per cent.

Trustees have typically cited a requirement for daily liquidity and costs as barriers to investment, but Nest’s award of a mandate to BNP Paribas Asset Management – its third foray into the asset class after previous allocations to BlackRock and Amundi – poses questions over the legitimacy of these concerns.

The French asset management house will create an open-ended diversified private credit fund for Nest, initially consisting of exposure to infrastructure debt, commercial real estate debt, European mid-market loans, UK small and medium-sized enterprises loans, and US mid-market loans, it was announced on Thursday.

The fund will offer active asset allocation, with principal repayments and interest reinvested to provide a total return.

Nest eyes pickup over bonds

Nest anticipates employing its first tranche of capital before the new year, and is eyeing an overall exposure to illiquid assets in the range of 20 per cent of its portfolio.

“With pensions saving across the UK, were going to follow a similar trajectory as Australia has seen where billions and billions of pounds are going to be invested, and we need to find decent investment opportunities for those,” says Mark Fawcett, Nest’s chief investment officer.

“While listed equities are going to be the mainstay of a DC scheme, we have a strong principle of making sure we are well diversified and have the ability to seek out opportunities elsewhere in the investment universe.”

The master trust is seeking a healthy premium over public fixed income markets, fuelled by illiquidity and the complexity involved in originating private credit assets. Crowding in sections of the market means selecting a manager with skill in origination is key, Mr Fawcett says.

“Even when things do default the recovery rates tend to be higher, but in general we’d expect defaults to be lower,” he adds.

Mr Fawcett is largely unconcerned by the illiquidity of this allocation, thanks to the overwhelmingly positive net cash flows the provider enjoys.

“Because we have our own platform, we are able to control how the money flows through the system. So as members approach retirement... derisking into more liquid assets across the board... they are transferring those private credit assets, at a fair price,” he says.

Nest says it has had to negotiate hard on price, but that asset managers are willing to entertain long-term partnerships given the future growth of DC. Meanwhile, BNP Paribas says it does not view performance fees as appropriate for private credit, negating another barrier identified by the recent patient capital review.

Fund selection still limited

The principle problem for Nest’s smaller DC peers, then, is the availability of illiquid assets on investment platforms.

Some platform providers have now made patient capital funds available, but according to Phil Dawes, head of institutional sales at BNP Paribas, their availability is far from universal.

“Where there is a barrier is with investment platforms,” he says. “They still will not accommodate these vehicles, they still require you to have a daily price, they still require you to have daily liquidity.

“I would urge investment consultants, trustees, DC schemes, sponsors, to really question your platform provider as to why they cannot accommodate these funds,” Mr Dawes adds.

Daily dealing not a requirement

As a master trust with a rapidly growing membership, Nest enjoys far more drastic positive cash flows than smaller, single-employer schemes, meaning that trustees will have to balance allocations to private markets against the cash calls that could come if a group of members decide to cash out.

“We sit down every month and check if we’re still cash flow positive,” says Robert Waugh, chief executive and co-chief investment officer at the RBS Pension Fund.

However, this should not be taken to mean that DC arrangements must provide daily dealing. The RBS scheme has split the diversified growth funds it uses into a liquid and illiquid fund – one caters for its cash flow needs, while the other is able to focus on real assets without watering down returns with liquid alternatives.

“We’ve worked with large partners and created fair daily pricing, so it’s definitely doable,” says Simon Chinnery, head of DC client solutions at Legal & General Investment Management.

“There are operational and administrative challenges but they absolutely can be overcome.”

However, Mr Chinnery doubts whether riskier equity investments are a natural fit for first forays into the illiquid space: “From the patient capital review, it was a little surprising that the focus was on the venture capital end of the market.”

DWP to consult next year

Further easements to investment in these assets can be expected from the government and regulators, according to David Farrar, senior policy manager at the Department for Work and Pensions.

Mr Farrar says the DWP plans to consult on adjustments to the charge cap early in the new year. He says that no change is needed to the level of the cap given that most defaults now charge significantly below this, and that simplification of the compliance calculation will give trustees the option of paying performance fees if they judge this to be in members’ interests.

“We aren’t saying performance fees are fantastic... it doesn’t necessarily incentivise in the way people might think,” he says. “But we don’t want to prevent people going into those structures.”

In addition, Mr Farrar says the Financial Conduct Authority will respond before the end of the year to a consultation on permitted links – technical regulations governing the assets that can be held in unit-linked funds.

The regulator has proposed updating its definitions to facilitate investment in “immovable assets”.