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Politicians on both sides of the Atlantic are in hellish to bring more pensions to the private market. The Trump administration is considering an order to open up access to the private market for American employees through the 401K pension system. This will make Main Street an entree into Wall Street and a high-risk adventure playground that has previously been a reserve for large professional investors.
Continental European regulators relax liquidity rules and price caps in defined contribution pension schemes. In the UK, Prime Minister Rachel Reeves oversees asset owners and managers about 90% of the Active Savers’ defined contribution (DC) pensions and invests 10% of the portfolio in infrastructure, property and private equity. Half of the money rings for the UK. If the signatories do not meet voluntary targets, the minister may make the policy mandatory.
However, let’s pause to raise some weird brows around the current private market hype. In the US, the potential popularity of private markets looks suspicious like a friendly Trump gesture towards Wall Street friends. But to be fair to Europeans, it is well intended to use their thrust-private markets to promote economic growth and strengthen retirement income.
While private equity and credits are escalating, public markets are shrinking. Companies have been staying personal for longer than ever. With easy access to private capital, many people don’t need to publicly access.
Members of the DC scheme have nearly 40 pre-retirement years. In this year, liquidity, the ability to easily buy and sell is an unnecessary luxury. However, the default option to invest most of the employs primarily in the cited assets abandons the opportunity to enjoy the illiquidity premium in private investment.
Private credit has also grown spectacularly. Advocates trumpet their all-weather attributes: regular cash flow, solid collateral, and first lien status that is preferred as creditors. Much of the growth has reflected regulatory constraints that have been holding banks back since the 2007-09 financial crisis. This promotes regulatory arbitration and provides banks with a large portion of non-bank funding needs. Private credit is the financials that rapidly grow acquisitions.
Icing in the investor case is that the private market provides diversification that reduces portfolio risk. However, there is a stump. Former SEC commissioner Alison Helen Lee points out that “darkness” is information-hunger for investments in the private market. These markets are tired of opacity, and limited liquidity is whimsical.
Just like risk, private market costs are high. Historically, these half-price ranges in capital markets are where major accidents occur, especially in venture capital where corporate mortality is high and there is a significant diversification of returns. This means that pension funds need to be skilled at selecting good managers. Whether many of these funds have such skills is controversial. Traditional wisdom means that large investors win this Darwinian freedom. But that’s not always the case. Look at the painful experience of the university’s retirement pension scheme with regard to water in Thames.
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Timing is important for investors to bring about oceanic changes in asset allocation. This is difficult because the number of private equity performances that have attracted investors is dangerously misleading. They have long been praised for the ultra-low interest rates that stem from the financial crisis. According to a study by McKinsey, approximately two-thirds of the total revenue from acquisition transactions concluded prior to 2010 can simply be attributed to multiple expansions and leverages on the market.
With Windfall’s rising interest rates gone, private share distributions of cash to investors have declined, and managers have struggled to sell assets purchased at boom prices, opting to hold their assets longer to avoid crystallizing losses. One way they do this is to lend their private credit arms to portfolio companies that are already borrowing high, extract dividends and distribute them, and pay the fees.
In Trump’s world of economic uncertainty, such hassle, leverage of rising prices, and self-dealing points to rising self-enforcement points and potential systemic troubles. Also, retail investors are being seduced, and they end up taking experts from the zombie company hooks, and stuffing them. And the continued flow to the private market risks diluting returns.
In his paper on money, John Maynard Keynes wrote: “If the enterprise is on the way, wealth accumulates what could be happening in the rif area. Perhaps politicians would be better focused on developing companies rather than messing around with pension fund assets allocation.
john.plender@ft.com
