Where performance breaches the charge cap – everyone wins!


Andrew Warwick-Thompson is quoted in the FT today claiming that “The government is pandering to the asset management industry” and that “Asset managers should be changing their fees structure to fit the charge cap, and not the other way around“. He is right, and any breaches of the charge cap through spikes in “carry” fees , need to be justified on an exceptional basis and not built into fee structures as a kind of regulatory arbitrage.

I’ve written on this before along the lines laid out in the FT, but I’m beginning to understand where there may be a need not just to recognize the challenge to the cap – but to encourage it.

The  Government has set out its agenda as follows;

  1. We want to see pension schemes finance growth opportunities in private companies , including many that will only realise investment gains in many years to come.
  2. In the meantime, we want the introducers of these opportunities to be rewarded for success by performance fees that we realise could be large, where there is extreme success (unicorns)
  3. So as to accommodate the spikes in growth and in consequent fees, we want to account for those fees over a number of years, so that the charge cap is not breached.
  4. We think this will encourage pension funds and asset managers to work together to finance growth opportunities in the private markets.

Through one lens, this is “pandering” and another it is “facilitating”. Andrew clearly thinks that this is pandering but I am relaxed about the relaxation of the rules because I want to see money invested in a more productive way.

A more productive way

The investable universe for large DC plans is shrinking, if we confine that term to publicly quoted equities. Despite the odd exception (Pension Bee being one), very few growing companies are listing on the world’s stock exchanges. The Norwegian Government  decided this year to cut the number of companies in its reference index from the current 9,000 to about 6,600.

The FT reports that the Norwegian Oil Fund (its Sovereign Wealth Fund) is further reducing its investable universe by divesting from smaller companies on ESG grounds. New screening will mostly affect smaller companies in developed markets such as the US and Europe. The fund has sold out of about 300 companies since 2012 due to ESG problems, something it calls risk-based divestments.

The shrinking of the “known world” means a search for “terra incognita”, the world previously unknown to many asset managers and to DC investment platforms.

Oystein Olsen, governor of Norway’s central bank, which houses the oil fund, said:

“The world is continuously changing, it’s not standing still. There are new challenges. To be a global leader, which is still the ambition, we have to move on.”

I would like to see my DC fund move on and I want to see investment into the kind of assets that have the potential for high growth and are meeting ESG considerations, most of these opportunities are off radar and most need new thinking on how they can be accommodated within our DC funds.

A case study

I was talking last week to one of the investment platforms for micro -businesses that invest in small companies like AgeWage and Chris Sier’s ClearGlass, businesses that have growth potential and meet a social need.

Finding , researching and presenting such opportunities is a tough business. Larger asset managers do not get their hands dirty but sub-contract this work to organizations such as Founders Factory, Syndicate Room and Newables. Firms like mine are selected for investment through funds set up at the very bottom of the corporate pyramid and we are expected to fail.  The attrition rate from firms at the seed stage of financing is so high that investment can only be justified by the likelihood that one out of sixteen of these firms will become a unicorn.

It may seem totally counter-intuitive for pension funds to invest in ventures like AgeWage and ClearGlass but that is precisely what the Treasury and the DWP have in mind when they consult on raising the charge cap.

And paradoxically, it is precisely the patient capital of DC pension funds that is most needed in our space and most suited to growing our kind of business. I put Fintech up as a case study for a new kind of investment and ask the question – could investment in Seed Capital happen within a conventional approach to charging?


I think that there are ways for pension schemes to incorporate investments in Seed Capital, into conventional AMCs which do not spike. But to do so, would be to constrain the entrepreneurial activities not just of organizations like mine, but of firms like Founders Factory Newables and Syndicate Room busy finding and presenting opportunities.

Shoehorning us into a world where the most we can be rewarded is constrained by a cap,  disincentiveses both the pension fund and the creator of the fund. For the sake of presentation of a smoothed AMC, the search for the unicorn is called off, capital is allocated to the usual suspects and the opportunity to make capital productive is reduced.

The issue is one of transparency, for early stage financing (proper venture capital) to be included in the portfolio of DC pension funds, there has to be an acceptance of high numbers of failures but equally that success means huge success.

Packaging VC funds into conventional AMCs simply doesn’t reflect what the investment is about and creates an opacity that is the opposite of what is required.

I don’t want pension funds to invest in organisations such as mine with an expectation of bluechip returns. I want them investing in me because I have the capacity to shoot the lights out – or go down with all guns blazing.

So while I agree with Andrew Warwick-Thompson that pandering to conventional asset managers is no way to run a charge cap, recognizing that there are exceptional opportunities where the risk/reward parameters are quite different from valuations based on EBITDA, means accepting a new way of charging and the occasional breach of the cap.

The critical learning is that where the cap is breached because of performance fees, everyone wins.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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4 Responses to Where performance breaches the charge cap – everyone wins!

  1. ConKeating says:

    VC investments do have the property that just a few companies are extremely successful and most fail abjectly – in the parlance they follow a power law. But so too do investments in traditional listed equity, as is shown by Bessembinder’s finding that just 4% of listed companies account for all of the value created in excess of the TBill rate.
    The simplest way to cater for this power law property is to invest in a widely diversified fund – really very similar to indexation in traditional funds. Attempting to pick winners is problematic because failure will result in extremely poor returns and there really is no evidence that winners can be picked systematically.
    This power law property is one reason why the majority of fund managers underperform market capitalisation benchmarks.
    Now DC funds do not need to buy investments which carry performance fees. They have open to them the route of buying into closed end investment trusts which themselves invest in VC, which may have performance fees. This has several further advantages – the first is the obvious liquidity but the more important is that the premium or discount to nav at which these funds would reflect the market’s view of the value added by the fund manager and their investment choices.
    Tinkering with the charge cap is the thin edge of a very undesirable wedge.

  2. henry tapper says:

    This makes sense Con, it would be interesting to hear views of those operating diversified VC funds as to the pros and cons of giving up the carry and finding an alternative way.

  3. Tom Britton says:

    I’m a firm believer that there should be a trade-off in VC fees between carry and annual management fee. Some VCs live fat off of the 2% annual that seems so standard so a 20% carry could be seen as excessive. For VCs to truly align with investors, either lower the annual so that it’s sufficient just to cover fund operating costs, or drop the carry. If you truly believe in your fund, as we do, 10% on a hurdle over 100 should still see a nice profit.

  4. Pingback: Are unicorns just for little girls? | AgeWage: Making your money work as hard as you do

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