The government has doubled down on its view that no change to the level of the charge cap is needed to encourage defined contribution schemes to access venture capital investments, but some experts doubt whether such high-risk investments are a fit for default funds in the first place.
On Monday, the Department for Work and Pensions confirmed to the Financial Times it would not seek to change the level of the current 0.75 per cent cap on annual charges, but is instead considering whether the calculation used to assess compliance can better accommodate the performance fees typically charged by venture capital funds.
A report by the British Business Bank published last week recommended the government press on with this methodology change, finding that retirement savings for an average 22-year-old could be increased by as much as 7-12 per cent if schemes made a small allocation to venture capital and growth equity funds.
The Treasury-backed bank also found that a 35-year-old with £25,000 currently invested in retirement savings could see a 6-10 per cent increase in their lifetime retirement savings, and a 45-year-old with a £50,000 pension pot could see a 6-7 per cent increase.
“Given the historical outperformance… there is significant potential for DC schemes to improve outcomes for their members by investing in the asset class,” it said.
I don’t feel there is a need to adjust the charge cap, but we should review this in a few years’ time to see whether it will have proved to be a barrier
Maria Nazarova-Doyle, Mercer
A DWP spokesperson added: “We consulted on a possible change to the charge cap to let schemes pay performance fees without jeopardising their members’ protection, and we are considering responses.”
‘Charge cap should be lowered’
Some of the UK’s largest DC providers – including Aviva, Legal and General and Nest – have committed to exploring options for pooled investment in patient capital assets.
But Brendan McLean, manager research analyst at Dalriada Trustees, said there is a question as to whether DC schemes should be used as a source of funding for Britain’s start-ups – the riskier venture capital and growth equity subsets that form the focus of the BBB study.
He said: “Making VC or more expensive funds accessible to DC members would increase the risks they face, as they are more likely to get ripped off and experience lower returns over the long term.
“I would be more inclined to see the charge cap lowered,” he added.
“VC managers only need about 10-20 per cent of their investments to be successful, as those that are make up for the rest,” he admitted, but said that trustees are likely to avoid a direct allocation in favour of diversified growth fund managers offering some exposure to these assets.
Others said the government and pensions industry should insist that asset managers adapt to their demands, rather than the other way round.
Maria Nazarova-Doyle, principal and market engagement leader at Mercer, said there are already fund managers prepared to work without performance fees. With most schemes currently charging well below the cap level, no further adjustment would be needed.
“I don’t believe we have to carve out an exception for private markets to make this work at this stage,” she said.
“However, this can always be revisited if there is evidence of managers not wanting to support DC due to the absence of performance fees.”
She added that the industry is “yet to experience any meaningful demand for DC investment in venture capital investment”, and that there are “plenty of alternative investments already in play in DC; including infrastructure, property and private markets”.
Performance fees ‘unlikely to change’
In its response to the government’s consultation, Octopus Investments wrote that performance fees are industry standard in venture and private equity, and so it is unlikely that this is going to change.
It said: “The process of investment, particularly in start-ups and scale-ups, requires an enormous amount of time (relative to the amount of money deployed), and the active management of these investments once deployed relies on a certain level of expertise.
“The revenue model of investment managers in this sector relies on the prospect of earning performance fees, and we believe that this will remain the case going forward.”
Chris Hulatt, co-founder of Octopus Group, said this necessitates a rethink of the charge-cap calculation.
“The charge cap and the impact of performance fees render it very difficult to structure access to funds unless there is some flexibility in how the performance fees are taken into account,” he explained.
Liquidity still a concern for DC members
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DC investors are typically considered to be able to tolerate illiquidity, as a young employee may have 50 years of membership before they retire.
However, Mr McLean warned that this is not always the case, making liquidity a key concern for trustees considering venture capital.
He explained: “Often investors would need to be committed for at least seven years… if a DC member moved their pension pot, maybe due to a change in job, etc, it could be an issue.”
