UK pensions are wary of ‘illiquid’ investments
UK government efforts to encourage pension funds to invest more in infrastructure, venture capital and private equity may fail as plan managers fear the move will leave retirement savers worse off .
Popular pension plans, with tens of billions of pounds in assets, largely avoid these less liquid sectors due to the higher costs and complexity of investing in these areas, but no guarantee of higher returns.
The government believes that using the pension funds for more so-called illiquid investments will help boost the country’s post-pandemic recovery.
Tensions between government and sections of the pension sector began to rise in March when, as part of Downing Street’s plans to ‘build back better’, ministers proposed giving Defined Contribution (DC) schemes – that do not promise a guaranteed savings pot – more flexibility to invest in illiquid sectors. Some 10 million people in the UK are saving through self-enrolling CD work pensions.
Two-thirds of DC plans are not directly exposed to “illiquids” in their main funds, according to a government survey released this year, while the rest mostly allocate a maximum of 7 percent.
“There has never been a better or more important time for a defined contribution pension plan to consider innovating its investment strategy,” Pensions Minister Guy Opperman said in a recent consultation.
“Investments in emerging sectors such as green infrastructure or innovative UK businesses fit well into the long-term horizons of DC programs, and are essential to help maintain jobs, our communities and the environment.”
The key change is a proposal, which the government wants to put in place by October, to relax an annual cap on fees charged by asset managers on pension plans of 0.75% of assets under management.
According to the government’s proposal, plan managers could adopt a five-year moving average performance fee to reduce the risk of exceeding the annual cap.
This would allow trustees to invest more in sectors, such as private equity and venture capital, which in turn provide seed funding to start-ups and other innovative companies. But these funds charge performance fees, or “interest”, in addition to the annual management fees. These additional charges would generally make them more expensive than fixed charges on listed assets such as stocks.
The fees of the fund managers are passed on to the savers, but many pension plan administrators are concerned that, since returns are not guaranteed, savers stand to lose because of the higher fees.
The Association for Pensions and Lifetime Savings, a professional body representing more than 1,300 workplace pension schemes with 20 million members and £ 1.3 billion in assets, told the government at the time of a consultation that she did not think the changes “would result in a significant change in volume.” investment in illiquids ”.
“The focus of the Trustees on obtaining low fees in a competitive market; the prudent person principle, which requires systems to carefully consider risk and reward; and operational barriers, such as the flexibility to move pots on demand and daily transactions, are likely to still result in only a very small proportion of the system’s investment in these assets. “
The 2013 Department for Work and Pensions analysis found that increasing the fees levied on pension plans from 0.5% to 0.75% would cause a saver to lose an additional £ 40,000 in charges over the course of of his working life. The analysis was based on a constant annual rate of return of 7%.
The average commission of alternative investment managers is around 1% to 1.5% for management fees and 15% to 17% for performance commission, according to a study published in a 2019 article by the all-party parliamentary group on alternative investment. management.
Nest, the state-backed corporate pension plan, refuses to pay performance fees and says those managers should reform their pricing structures.
The British Private Equity & Venture Capital Association, an industry body. argues that performance fees are justified and that pension funds miss out on higher returns by avoiding illiquids.
“The PE / VC interest model is the long-standing global market standard for aligning the interests of PE / VC managers with their investors,” he said. “It is only paid out after strong performance has been achieved and investors have realized their returns.”
Some figures from the pension industry have said the government is being easy on asset managers by relaxing the fee cap, instead of forcing asset managers to lower their fees.
“The government appears to be pushing trustees to invest ‘patriotically’ in order to help the UK economy recover from the Covid pandemic,” said Andrew Warwick-Thompson, former executive director of regulatory policy at The Pensions Regulator and now a professional director of Capital Cranfield, a trust company.
“This objective conflicts with the fiduciary duties of the trustees to consider all investment opportunities and choose those which they believe will be in the best interest of securing the retirement benefits of their members.”
Warwick-Thompson said he did not believe the government would force regimes to invest in a particular way if its reforms were not effective, saying the political damage would be too great “if things went wrong.”
The government has said it is not its role to advise pension plans on the merits of certain asset classes and that it will not seek to do so.
“We know that many defined contribution plans seek access to a more diversified portfolio of assets, including illiquid assets, and our policy is that the trustees of these plans should be free to determine which investments are best for their purposes. members, ”he said.