GPs need to lower fees to attract more interest from the UK’s defined contribution pension schemes into growth equity and venture capital funds, a study has found.
A report by the British Business Bank and Oliver Wyman reveals that affordability and accessibility are some of the issues faced by DC pension schemes that want to expand their exposure to the two asset classes.
“The high costs and carry associated with investment in VC/GE funds create a challenge for DC Schemes trying to access the asset class,” according to The Future of Defined Contribution Pensions.
DC schemes are constrained in the amount they can spend on investment and administration, both by commercial considerations like internal fee budgets, and by the regulatory 75-basis point cap on the total charges attributable to an individual member in the default fund, the report noted.
“In particular, without changes to current VC/GE fee arrangements, the charge cap may in some circumstances make it difficult for DC Schemes to accommodate the carry due when investments are very successful.”
DC scheme providers are constrained on fees both by commercial considerations like internal fee budgets and by regulatory considerations. This study has identified that changes to fee arrangements are likely to be required to unlock large scale DC investment in this asset class.
With the majority of portfolio allocations tilted towards equities and bonds, the report also argued that UK pension savers are missing out on better returns generated by investments in growth equity and VC.
“The average 22-year-old entering a default fund and following a ‘lifestyle’ approach could achieve an approximately 7-12 percent increase in their total retirement savings. This is achieved by an average ~5 percent allocation to VC/GE over their working life and assumes a premium over listed equities that is in the range of what has been achieved historically,” according to the report.
Even for older workers, the potential increase in returns would be significant. For example, a 35-year-old with £25,000 ($30,769; €28,166) currently invested in retirement savings would see an approximately 6-10 percent increase in their lifetime retirement savings, the report noted.
Other benefits to allocating to a VC/GE portfolio are diversification, lower risk and high exposure to innovative and high-growth tech companies that are staying private longer. In the UK, investment in SMEs grew to £6.7 billion last year from £3.9 billion in 2016, according to the report. Much of the investments are in technology, life sciences and other intellectual-property based businesses that have produced in recent years unicorns including digital bank Monzo and Cambridge-headquartered cyber-defence company Darktrace.
To capitalise on these investment opportunities, stakeholders from industry, regulators and government “need to take action now to make this happen”, the report highlighted.
For this to happen the study proposes that DC schemes invest through a pooled investment vehicle by an existing investment manager or through a vehicle created or jointly owned by DC pension schemes. In time, DC schemes could also invest in companies directly. Meanwhile, pension pooling could result to a roughly 5 percent allocation to VC/GE.
Legal & General, the UK’s largest DC pension manager with £85 billion of assets and already an investor in UK VC managers, is exploring ways to get access to more VC and growth equity investments via a fund of funds approach, it said in a statement about the report. Nigel Wilson, chief executive of Legal & General, noted, however, that more needs to be done to democratise access to the asset class.
“The UK has some of the best universities in the world, which are fuelling innovative, commercial ideas including AI and data-driven businesses as well as scientific breakthroughs,” he said. “However, the innovative companies at the forefront of this disruption are now staying private for longer, delivering returns to a small group of private market investors.”
In 10 years, the total AUM of workplace DC schemes is expected to reach £1 trillion, more than doubling in size from current levels, the report noted.
British Business Bank – the UK’s economic development bank – and consulting firm Oliver Wyman conducted interviews with more than 50 organisations across the pensions, VC and growth equity industries, as well as regulators and those in government, for the study.