PLSA: will the UK’s push to invest in private markets lead to more investments in renewables?

The UK government’s push to attract the country’s £2.5trn in pension assets towards investments in private markets was front and centre of the nation’s largest pension industry gathering taking place in Manchester this week.

UK pension schemes have historically had a rather conservative asset allocation, with most corporate defined benefit schemes in the UK now being closed, the bulk of their assets have been invested in fixed income.

However, schemes that are still attracting new money, open defined benefit schemes such as the £369bn Local Government Pension Scheme (LGPS) and the rapidly growing defined contribution (DC) market have been at the centre of the government’s latest push to attract institutional investment.

In his Mansion House speech in July, UK chancellor Jeremy Hunt set out a series of proposals to draw commitments from institutional investors. While his proposed reforms do not make investments in particular asset classes or regions mandatory, Hunt said his reforms could “unlock” £75bn of additional investment in UK growth industry and strongly implied that this could ultimately attract funding to the renewable energy sector.

His proposals were front and centre at the annual Pensions and Lifetime Savings Association (PLSA) conference this week, the first nationwide industry gathering since the announcement of the Mansion House reforms, with more than 1300 delegates in attendance. 

Net Zero Investor's Annual Conference | 11th December 2023 | London

Mixed responses from the LGPS

For the UK’s local government pension funds, investment in renewable energy infrastructure is by no means a novelty. The LGPS, which has been consolidated into eight different pools has been investing in renewable energy for many years, both through the pools and 86 local pension funds in England and Wales.

Examples include LGPS pool Border to Coast, which says it has now invested more than £8.3bn in assets to support the energy transition and the infrastructure platform GLIL, which holds significant investments in UK windfarms and battery development.

The government hopes to formalise these commitments by getting the LGPS pools to invest at least 10% of their portfolio in private equity, a proposal raised in an ongoing government consultation.

But at the PLSA conference in Manchester, the government’s ambitions were met with mixed responses from the LGPS. Neil Mason, chair of the PLSA’s local authority committee, highlighted that the LGPS has already been investing in private markets for “very many years” and is supportive of this asset class, but warned that the timing of the reforms could be better for the scheme.

Indeed, rising bond yields have meant that the LGPS is now fully funded, at an aggregate funding position of 103%. This meant that there was now less incentive for funds to invest in riskier assets such as private equity, he said.

This represents perhaps the biggest obstacle to future commitments in renewables as the LGPS is now interested in taking risk off the table, Mason said.

Growing DC interest

The move towards private markets marks a far bigger step for the UK’s rapidly growing DC market, which has historically been invested in index-based strategies heavily focused on developed market equities.

A strong focus on cost effectiveness, driven by both industry competition and regulatory constraints has meant that investing in private markets and the energy transition in particular has for a long time not been on the cards.

But a series of potential policy changes, including a shift towards value for money and an easing to the charge cap on fees mean that private market assets could now be more accessible to DC funds.

Coinciding with the Mansion House Speech, the chancellor revealed that nine of the nation’s biggest master trusts had signed up to a Mansion House Compact, pledging to invest at least 5% of their portfolio in private equity by 2030.

Nest, the country’s largest master trust which now manages more than £30bn in assets has been the first DC investor to include private equity and other private market assets in its portfolio. Over the last two years, it has made significant commitments to UK wind energy and is now on the lookout for a timberland fund manager.

But at the PLSA conference, Nest CIO Liz Fernando emphasised that private market investments could be riskier and that higher returns were by no means guaranteed.

Speaking on the sidelines of the conference, several asset managers offering climate solutions in private markets told Net Zero Investor that they had experienced growing interest from DC funds on the back of the Mansion House Speech.

But they also added that there were still significant obstacles to putting this ambition into practice. One key challenge is the requirement for daily pricing in DC funds, with private market managers often only offering bi-annual or annual valuations.

Another obstacles are cost and scale, with projects being either to small to attract institutional capital or DC commitments not being significant enough to be delivered within their relatively tight cost budget.

Training and lack of knowledge of private markets among DC investors could also be an issue, one manager told Net Zero Investor. “We have seen a huge uptick in interest but we haven’t yet seen a huge uptick in adoption,” one manager said. Many schemes had started off their net zero efforts with Task Force on Climate-Related Disclosures reporting, with inroads into investing in renewable energy being a possible next step.

Speaking at a panel on DC investment, Tegs Harding, director at the Independent Governance Group and a trustee for the Legal and General Master Trust, said that she sees scope for a drastic expansion of private market assets in DC portfolio’s, which could soon account for about a third of portfolios for some of the largest master trusts.

Dominic Byrne, head of DC strategy for EMEA at BlackRock sees DC as a key area of growth for renewables. “We are seeing a greater number of DC schemes consider private markets as a way of further diversifying portfolios. We believe that private markets can play a critical role, alongside public markets, to help DC defaults achieve their objectives.”

“Education is important. We have to remember that this market isn’t starting with a big alts programme. Buying private markets is not like buying an ETF. What defines your success in private markets is your ability to source deals and work with the right managers, it is not as simple as investing in an ETF” he added. 

“Operations are another consideration, with DC schemes attracting large cashflows, investments will need to be constantly rebalanced” said Byrne.