Recently galvanised by the Mansion House Accord, the private markets investment initiative to enhance pension fund returns and support economic growth, UK defined contribution (DC) schemes have been increasing their allocations to non-public assets as part of their pledge to allocate 10% of their main default funds by 2030, with 5% ringfenced for UK investments.
For many DC schemes, private equity investment has been a chief focus for strategic allocation, a strategy we focused on and analysed in our previous paper last year. This time, we turn to private debt, a broad asset-class that has grown rapidly and evolved in recent years.
In this paper, we present a hypothetical study to illustrate the potential impact on asset accumulation of including private debt, how that affects the level of income that can be bought at retirement, and how the high-income distribution attributes of the asset class are attractive for retirees adopting a drawdown strategy in the decumulation phase.
Executive Summary
- As UK DC schemes look to diversify from public markets and within private assets, we believe the benefits of private debt in the accumulation and decumulation phases should make it a key consideration.
- Key benefits include the potential for enhanced risk-adjusted returns (see below), reliable income and portfolio diversification.
- While there are several types of private debt, we believe a combination of corporate direct lending, asset-based finance and residential transitional loans are an optimal fit for most UK DC schemes in achieving multiple objectives for their members.
- In modelling two hypothetical DC portfolios—one with public assets only for fixed income allocation, and the other to include private debt—we show the portfolio including private debt improves both the median (increasing the accumulated pension value by 5.2% net of investment management fees) and the range of returns.
- Our analysis also shows that the higher income distribution of private debt supports potentially retaining allocations in private debt beyond retirement, facilitating higher income drawdown during the decumulation phase.
