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DC fees are barrier for private markets, notes CFA Institute

defined contribution (DC) pension schemesGreater participation by defined contribution (DC) pension schemes in private markets is important as public equities reduce in number – but their involvement is also restricted by the regulatory focus on fees, according to investment professionals.

This is one of the main findings by a CFA Institute report that notes the decline in listed public equities worldwide has potentially negative implications for retirement savers and means private markets are becoming bigger and more critical to economic activity – including DC investment.

Calls for more involvement of DC pension funds in private markets are getting louder, the CFA said, but noted cost structures were a problem.

For example, in Norway there is a requirement that the scheme operator must pay the asset management fees rather than pass these fees along to the account beneficiary (as in most other countries) and this gives DC schemes a strong incentive to search for lower cost asset managers.

And in the UK, there is a cap on the total expense ratio of DC default schemes set at 0.75% per year. There is even pressure to add in transaction costs to the cost cap.

Both the Norwegian and UK experience has increased incentives for low-cost passive investments.

Sviatoslav Rosov, lead author of the CFA Institute report, says: “Typically, plans with a one-dimensional focus on costs will be able to access only passive equity or fixed-income index exposure, and they are not likely to be able to invest in private markets absent new, and cheaper, investment products from the industry.”

The report, called ‘Capital formation 2: Investing pension contributions in private markets responsibly’, says listings in public markets are “waning” and private markets are becoming bigger and more critical to economic activity.

Among other findings are that eligible assets for DC funds would have to be reviewed to allow DC schemes to participate in private markets.

Rosov, who is also regional head of capital markets policy at the CFA Institute, also said that policymakers should not assume that a shift towards private markets would automatically result in higher risk adjusted returns for pension funds.

“While the range of investment options would expand, private market outperformance of public markets is a story with much nuance,” he said.

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