Asset Allocation

UK’s CEPB favours private markets

The United Kingdom’s £2 billion ($2.6 billion) Church of England Pension Board, CEPB, is slashing its equity portfolio and investing much more in private markets. The significant change in strategy at the defined benefit, final salary scheme for church clergy, a sister fund to the larger £8 billion ($11.1 billion) Church Commissioners which manages the church’s endowment assets, comes as the fund seeks better returns and less volatility.

It is also a strategy emboldened by youth: CEPB is 15 years away from peak benefit payment and is forecast to double its AUM over the next 10 years.

The fund is also supported by a strong commitment to keep the scheme open by the church, in contrast to most other UK DB scheme sponsors.

“We are pretty much all the things that don’t really exist nowadays,” says CIO Pierre Jameson who joined 11 years ago when the CIO role was created, and the fund only had $1 billion AUM. “It makes us quite unusual.”

CEPB’s 85 per cent allocation to return seeking assets (the remaining 15 per cent is in liability matching gilts and corporate bond allocations managed by BlackRock and Insight Investments) is currently divided with two thirds in public equity and one third in private markets to infrastructure, hedge funds, real estate and private debt. Now Jameson plans to cut the public equity allocation to around 35 per cent of the growth portfolio and plough the proceeds into infrastructure, private debt and private equity.

This will amount to doubling the allocations to infrastructure and private debt to 20 per cent and 8 per cent respectively and building a private equity allocation from scratch to account for 7 per cent of AUM over the next 10 years. Here CEPB is on the cusp of making its inaugural fund of funds investment.

“We have found our managers, but it’s not public knowledge yet,” he says.

Jameson expects cash yields of 5-7 per cent annually in infrastructure and the “same again” from the upside from management of the businesses giving an IRR of around 15 per cent. In private debt he is looking for yields of 6-8 per cent depending on where the fund is invested in the capital stack; in private equity he is targeting returns at the high end of public equity – around 8 per cent a year.

In contrast, volatility can cost the fund dearly and escaping from its swing is the other reason, alongside better forecast returns, for reducing equity. UK pension schemes must mark to market, and the private investments to which they mark are much less volatile than public equity, he explains.

“Private assets are valued according to cash flows and realistic expectations for underlying business. They are not pushed here and there by market sentiment.”

Although public equity may, over the long term, return 6-7 per cent a year that comes with 18 – 20 per cent volatility. The fund has tried to navigate volatility by allocating to defensive equity strategies which typically include low beta names like utilities and telecoms and negatively correlated stocks. But Jameson notes there “is only so much we can do as it is all publicly traded.” He estimates these defensive allocations reduced volatility from 18 to about 12 per cent which “helped,” but is nothing like the calm of private markets. In another challenge, UK pension schemes triannual review process makes navigating volatility even more important. “Where markets end up at the triannual date can give a random outcome. We will suffer less from this with a larger allocation to private markets and stop that volatility running through into contributions the sponsors have to make.”

Fee burden

The decision to invest more in private markets, where investment is in third party funds, will increase the fee burden but Jameson is confident the returns and loss of volatility will make it worth it.

“Private market assets are expensive to have managed. If you go in with a mindset to give up a third of your gross return you won’t be disappointed; this is a good rule of thumb,” he says. CEPB’s consultant, Mercer, provides it with an annual review of what other pension funds pay in fees.

“We are in the ballpark,” he says.

Jameson is also heartened by recent sharp falls in active equity fees – the remaining equity allocation will shift from a passive/active split to wholly active strategies. The rules of supply and demand usually dictate that investor demand for strategies or particular asset classes gives the asset managers that supply them the opportunity to raise fees.

However, the fall in fees for quantitative equity strategies (like passive but still classed as active mandates nonetheless) bucks the trend since it’s come just as more investors pile in.

“Fees have come down precisely because of the increasing popularity of these kinds of styles of management,” says Jameson who estimates the fund is now paying two thirds of what it was in its quantitative allocation. “These managers have a fixed cost base so they can take on new assets on an incremental basis that is attractive. It’s like a sausage-making machine: once the machine costs are covered, making additional sausages is cheap.” 


The return profile of CEPB’s infrastructure allocation is core-plus and core- plus plus, invested in manager-run strategies that favour buy-and-hold assets and buying assets, improving them over time and selling them to other investors in a private equity flavor. The portfolio has evolved in three waves from an initial investment in European funds only, to a global remit. Now, in a new development, he is looking at more industry or regionally specific investments. Typical investments include economic infrastructure around communications, transport and distribution sectors. The fund is also invested in energy infrastructure and utilities including water. Only 12 per cent of growth asset are exposed to the UK economy since CPB removed its UK bias 3-4 years ago. That has helped it step away from the current competition in UK infrastructure where Jameson observes demand from new LGPS mega funds has led to assets being overbid.

Overpaying is a key area in his manager due diligence.

“Because infrastructure assets are overbought, it’s important to make sure you’ve got managers that are not going to overpay,” he says.

Here he demands clarity from his managers on what proportion of assets they buy on a bi-lateral basis versus asset auctions, and that managers have “sound procedures” in place for asset auctions where prices get bid up. The best assets, he says, are those where the seller isn’t chasing the highest price because they have primary concerns around investment ethos, or want the asset managed in a particular way going forward. Asset auctions where an existing owner wishes to sell, and the sole objective is to get as high a price as possible, are a “recipe for overpaying,” he says.

CEPB will soon boost its internal team of five to nine with new hires fleshing out the ESG team. The fund works with 26 managers, predominantly in North America and Europe, across 28 portfolios. Jameson estimates he meets with managers twice a year. That will increase if the allocation has underperformed, there is a change in corporate structure or strategy, or if there has been a significant outflow of funds, he concludes.

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