A cap on workplace pension charges should be adjusted to unlock the potential of “significantly” higher returns for younger savers from investing in riskier start ups, a government-backed report has recommended.
Managers of UK workplace pension schemes, which have more than 10m savers, are often unable to back early-stage businesses, through investment in venture capital funds, because of fees which risk breaching a 0.75 per cent ceiling on charges.
Venture capital fees are significantly higher than many other asset classes, such as passive management of equities, because of the costs of managing an unlisted portfolio of high-growth companies and carried interest (performance fees) charged by fund managers.
But analysis by the British Business Bank, which is government-owned, found retirement incomes for younger workplace pension savers could get a boost through investment in venture capital.
The BBA analysis estimates the average 22-year-old automatically enrolled into a workplace pension, and following a ‘lifestyle’ investment approach, could achieve a 7-12 per cent increase in their total retirement savings by allocating around 5 per cent of their fund to venture capital over their working life.
“Given the historical outperformance of VC/GE [growth equity] investments, there is significant potential for defined contribution (pension) schemes to improve outcomes for their members by investing in the asset class,” said the report, published on Wednesday.
The BBA, which helps find finance for growing businesses, has made several recommendations to boost venture capital and growth equity investment, including encouraging managers to change their fees.
“Over time, new fee arrangements will be required if schemes are to make significantly increased allocations to the asset class,” said the report.
The report said a 0.75 per cent charge cap on fees in the most popular funds used by workplace pension savers made investment in the asset class “less attractive”. It said adjustments to the 0.75 per cent calculation methodology, to account for carried interest, could ease investment in venture capital.
“In principle, there is a real case for trying to create safe conditions for DC schemes to invest more in long term investment opportunities,” said Mick McAteer, co-director of the Financial Inclusion Centre, a think-tank, and a former board member of the Financial Conduct Authority.
“So, I can see the case for modifying the charging structure to accommodate investment in alternatives within the overall charge cap. But this is early days. If this is to be done then there are a number of protections which need to be put in place.”
The Association of Investment Companies, which represents closed-ended funds — one of the structures floated to host the proposed VC investment vehicle — welcomed the report.
“The problem with some default DC schemes is that they’re exposed to too little risk,” said Ian Sayers, chief executive of the AIC. “Having a modest exposure to higher growth companies will be a good thing.”
The report comes four months after the suspension of Neil Woodford’s flagship Patient Capital Trust owing to liquidity problems caused by its high exposure to unquoted and early stage companies. Mr Sayers said the challenge for advocates of the proposal would be convincing investors that Mr Woodford’s woes were specific to individual circumstances of his fund rather than an inherent problem with investing in illiquid assets.
“People will ask ‘why on earth would you do what Woodford was doing for pension funds?’” said Mr Sayers. “But the risk of an investor not meeting their retirement objective is a greater risk than investing in VC assets.” He added that the fact that DC schemes would allocate a small amount of their assets under the proposal mitigated the potential risks.
