The growing use of private markets in defined contribution (DC) schemes could squeeze active management out of listed portfolios as schemes come under pressure to manage fee budgets, according to Wellington Management.

Wellington Management UK DC client lead, James Myhill, warned that as schemes increase allocations to private markets, a greater share of their overall fee budget is likely to be committed to actively managed illiquid assets.

“The risk is that this may result in a portfolio that is not well suited to the challenges of the next 20-30 years, with relatively limited flexibility to respond given the illiquidity of private market investments.”

Myhill argued that active management could continue to play an important role within listed markets, particularly if the market environment becomes less supportive of the passive equity strategies that have performed strongly over the past two decades.

He noted that an active approach could give schemes greater flexibility to address emerging risks and avoid excessive concentration in a relatively small number of large US companies.

“The move towards passive equities has served investors well over the past 20 years and has proved very difficult to outperform.

“However, the stability of global markets that has supported this approach cannot necessarily be relied upon over the coming decades.”

He highlighted emerging markets as one area where active managers could potentially add value, arguing that lower levels of analyst coverage and the importance of local expertise create greater scope to identify opportunities not captured by passive approaches.

Myhill said this was particularly relevant further down the market-cap spectrum, while deeper company-level research could also help investors assess ESG-related risks in emerging markets.

“Ultimately, having a deeper understanding of the individual companies in which you are investing is critical,” he added.

Meanwhile, Wellington also identified multi-asset credit as an area where active management may be particularly suited to DC portfolios, arguing it could provide access to a broader range of global fixed income markets, including private credit, without necessarily being treated as a
completely separate allocation.

However, Myhill acknowledged that fee sensitivity remained one of the key challenges facing DC schemes.

“We hope that, over time, the focus increasingly shifts towards value rather than cost alone.”

“Looking at returns net of fees and assessing the value that differentiated or specialist strategies can bring is more important than focusing solely on the headline cost.”

Looking ahead, Myhill predicted that DC default funds were likely to continue evolving towards a combination of low-cost beta, specialist active strategies and greater private market exposure.

He added that maintaining a focus on value for members as the market develops would be central to ensuring DC schemes can continue to improve long-term outcomes for savers.

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