Mercer's Tobias Ripka looks at how schemes can use private market investment to achieve their objectives in a highly volatile market environment.
With a private market allocation, institutional investors can participate in attractive longer-term opportunities without having to be concerned about day-to-day volatility, and can further realise an illiquidity premium.
While each sub-asset class has different but very attractive risk/return characteristics, private market investments share similar implementation challenges that have to be addressed to make such investments truly successful.
Key points
Private market allocations should be part of a diversified pension scheme portfolio.
Carefully select the optimal implementation model considering all critical arguments.
Compare costs in a holistic manner – management fees are one important element but not the only one.
Challenges include extensive investment due diligence, detailed legal reviews of documentation, ongoing cash flow management (capital calls and distributions), coordination of foreign tax matters, etc.
Additionally, the high level of performance dispersion evident across private markets calls for adequate diversification by managers, strategies and time.
To access private markets, investors have to choose between two fundamental implementation routes: investing in private market funds directly, thus driving the implementation process; or delegating the implementation process to a private markets specialist or adviser, either via pooled fund of fund solutions or separate accounts.
While high-quality portfolios can be built using all these access routes, a key difference is the level of ongoing involvement and a direct trade-off between full control and flexibility, and the operational burden.
A fully delegated implementation via a pooled fund of funds solution is the most time and resource efficient route
Direct investments
Direct investments in private market funds are best suited for investors looking for a high degree of involvement across the full investment process.
A successful direct implementation typically requires significant internal asset class experience, a reasonably large portfolio and target allocation and most importantly, a dedicated team that can develop the private markets allocation and manage ongoing work without distraction from other responsibilities.
There should be an efficient decision-making process in place, in particular to handle short-notice requests and capital calls, and to be able to secure capacity with top managers and funds in high demand – which often require quick decisions.
Pooled funds
A fully delegated implementation via a pooled fund of funds solution is the most time and resource efficient route, but offers limited scope to tailor the portfolio structure.
This implementation route can be suitable for investors of all sizes looking for a minimum level of ongoing involvement and no need for customisation.
Also, larger pension schemes use this route regularly to access private markets as it provides high implementation certainty with a minimum level of operational involvement and burden. Larger commitment sizes should also result in more attractive fee structures.
Separate accounts
Delegating the investment and implementation process via a separate account allows for a high degree of customisation but requires a sensible minimum size to make this route cost efficient.
Compared with pooled funds, set-up costs and ongoing charges for administration, accounting, etc are not shared with other investors.
This model offers flexibility to define the preferred investment vehicle and the preferred level of involvement and delegation.
The key objectives are, however, typically to gain access to top funds via the private markets adviser, outsource as much operational burden as possible, but keep control over the final investment decision.
Cost considerations
Costs are often considered the key driver for selecting the right model.
If considered on a full cost basis – including advisory fees for investment/legal/administration/accounting/monitoring support, internal time and resources, potential opportunity cost for missed investment opportunities or limited access to top managers versus an all-in fee for a delegated solution – the total cost level tends to be in a similar range across the various access models.
The decision about how to access private markets should therefore be driven by available resources, willingness to get involved in operational work, and the internal experience with private markets.
The right time to focus on fees is when the optimal model is selected considering all critical arguments.
Tobias Ripka is head of investment solutions at Mercer Private Markets
