So, the logical solution is to find someone that has the money to make such investments and persuade them to do so. This is effectively the challenge that the Mansion House Compact, and newly added Accord, seek to resolve.
Individuals saving for their retirement with the firms that have signed up to the Accord will, via the default investment arrangements of their personal and workplace pensions, now see up to 10% of their savings invested into private market assets such as infrastructure projects, renewable energy and social housing, as well as the financing of early-stage companies via private equity and unlisted bond arrangements. The voluntary target specified in the Accord is for at least half of these assets to be UK domiciled, although exactly what classifies as UK domiciled is yet to be clarified. This represents a significant bias (in investment allocation terms) to the UK.
The UK Government, and firms signed up to the Accord, assert that the measures will help drive forward the UK's domestic growth agenda and increase returns for pension savers. Sounds good, doesn't it? So good in fact that before we all rush ahead it would be remiss not to pause and consider if there any potential downsides.
Firstly, it is a bold claim that private markets assets are expected to outperform. Can this be said with a degree of confidence and, in particular, will such assets outperform, net of all fees, a passively invested global equity portfolio over the long term? The answer to this is by no means certain and we will have plenty of time ahead to deliberate the point whilst we wait for sight of the actual results to come in. For now, perhaps the more telling questions to pose, which are more easily answered, are should we expect UK domiciled private market assets to outperform their global counterparts, and why? We can immediately note that there are very specific UK structural and regulatory headwinds that make it difficult to see a positive response here.
To my knowledge, no one has yet put forward a compelling investment thesis for allocating to UK private markets over global, at least not one that has garnered consensus. I recall well the economic theory that was drummed into me during economics lectures all those years ago, specifically how when chasing returns asset allocators are wise not to restrict their opportunity set, and particularly not to rely heavily on one region with all the idiosyncratic risks that can bring. Much better to consider the global opportunity set. And, with this point in mind, one must ponder why if the UK market offers such promising investment projects the financing for them hasn’t been forthcoming already? Surely, if the net returns on these UK investments are favourable then neither the Compact nor the recent amendments contained in the Accord would even be necessary, would they...?
Another key challenge to overcome is where will we find all these compelling investment opportunities? As all professional investors know very well, sourcing attractive assets in private markets is a skill, a rare one, and the market supply of such assets is constrained and often very lumpy. Yes, UK Government can help in pointing investors towards what it sees as much needed infrastructure projects, but that doesn’t mean they are financially viable investments (anyone recall the recent, unsuccessful biding rounds for UK renewable energy projects?). And whilst the UK has some of the best universities in the world, with well-established incubators helping to identify and fund newly created companies and technological advances, the available capacity here is very limited indeed.
We can read something into the fact that the signatories to the Accord highlight the need for UK Government to play a key role in ensuring and facilitating a sufficient pipeline of investment opportunities. This, I think it is fair to say, is not a skill that governments of any political shade have demonstrated to date, and clarity will need to be forthcoming on how such a framework is to be established and function.
But enough of the investment reality check. As a proud Brit, I'm all for singing the praises of the UK and heralding the benefits of investing into our great nation, and I very much get the case for the societal benefits that can flow from domestic investment. And maybe that should be answer enough in itself – in that pension savers should be prepared, if needed, to justifiably 'give up' some potential return to invest in the society in which they will participate and benefit from into their retirement.
I’m minded of a new phrase that has recently slipped into the investment lexicon. Market participants now talk of helping to facilitate 'the democratisation of private markets'. It has never been clear to me what this phrase means exactly, but the generally agreed notion behind the words is that everyday pension savers will have an opportunity to access attractive returns from private assets that were, until recently, only available to institutional investors (who, by the way, use them more for diversification purposes than return generation). The word ‘democracy’ has its origins in Greek: demos, meaning people, and kratos, meaning power. It is usually understood to involve stakeholders being given a choice or say in the governance framework that represents them. By comparison, the direct voice and views of the people, the pension savers, have been notably lacking in the debate around the Accord.
Another key observation is that whilst returns from investments are uncertain, fees are certain, and the asset management charges for private market funds are typically much higher than for listed assets. So, whilst these investments may offer pension savers the prospect of higher returns, their inclusion in default arrangements will also provide certainty of higher fees for the product providers. Hence the need for the shift in narrative that we have seen, away from cost minimisation to providing ‘value for money’.
For now, it’s clear the asset management industry has chosen en masse to voluntarily commit to allocating a proportion of DC savings to private market assets, with a sustained bias to the UK market. Some commentators have pointed out that this action may avoid the potential imposition of a government mandate to invest in UK private assets, which would effectively lead to state centralised control of asset allocation. One could view the Accord as acceptance by the industry of the direction of travel that the Government would like to see, in the hope that going along with it voluntarily will avoid compulsion. Imposition of a UK Government mandate would probably have felt uncomfortable but, perhaps somewhat ironically, it would clarify the position for trustees and advisers who might be uneasy about amending existing default investment arrangements to include private markets, particularly given recent levels of market volatility.
As we go forward it is crucial that there is clear and transparent oversight of the value added for savers, net of all fees – both in terms of explicit investment returns and the societal benefits. Further the Government and investment industry should be prepared to take accountability for the long-term impact, whatever it proves to be, on the pots of pension savers. However, given the timescales involved it is fairly likely that those setting the policy and signing up to the Accord will be well into their own (comfortable) retirements before the outcome on savers is clear.
Oh, and one last call to attention – for those savers who prefer not to see their money allocated in this way, there should be the choice to ‘opt out’. That’s not quite the definition of democratisation, but choice in such matters is generally considered a very good thing.
Paul Francis, Head of Alternatives – Quantum Advisory