Julius is one of my favorite people, always open to new ideas, he’s currently a scheme strategist at rising star mastertrust – Cushon
Private market investments, cost disclosure and value for money in DC
There is increasing debate about whether and how cost disclosure and the charge cap might be amended to encourage DC investment into venture capital and other private markets assets.
There are many reasons why DC schemes might want to invest in private markets on behalf of their members: to deliver returns that listed markets may no longer offer, to improve diversification and to deliver impact that can make members proud of their pension.
A key obstacle is the dominant focus on price as the primary driver of value. Price is important, not least because it’s under our control, but lowest price will not necessarily deliver the best member outcomes.
Any DC scheme that includes a decent allocation to private markets, all other things being equal, is going to find it impossible to compete on price with one that doesn’t. If schemes are selected (as is often the case) on the basis of a very low default fund TER, members typically won’t get exposure to private market assets. But a low default fund TER doesn’t give the full picture on costs, let alone on value.
Cushon responded to the recent government consultation on performance fees and other barriers to DC investment in private market assets:
“Some easement in the way illiquid investment fees are consolidated into the headline TER would clearly facilitate greater access to this asset class. Should the Government therefore be minded to relax regulation, care should be taken to do this is a way that facilitates access to illiquids, while avoiding any significant risk of member detriment.
Cushon notes that all costs incurred by members impact the member level return. Some of these costs can be significant (like property management costs) and are not currently included in the TER.
Similarly, transaction costs are not reported within the TER.
Other costs, that can still be material to members (like spreads) are not included in the TER or even in the ex post fund performance that is reported to members.
A member level IRR is the only ex post metric that captures the full impact of value chain cost management by investment managers on member outcomes (albeit in conjunction with fund returns and other provider costs that fall on members).
Cushon believes that members, employers and their respective advisers need to have access to all categories of cost that impact outcomes. This requires full charge disclosure via both member level IRRs and fund level costs. But it demonstrably does not require all these to be disclosed as a single figure. Indeed it is clear that a proper analysis of whether costs represent value for money already requires the separate disclosure of different figures.
Cushon suggests therefore that illiquid asset management costs could be captured and disclosed separately.”
Cushon believes that a separate disclosure of any fees associated with private market assets would encourage a focus on value over price. It would encourage buyers to consider whether they want private market assets to be included in default strategies. Where they do, comparisons between private market strategies and their costs can be made.
It’s clear that the government wants to encourage investment into productive finance by pension schemes, but at the same time wants to avoid being seen to direct trustee investment decisions.
Just as regulation and guidance have established an expectation that trustees will specifically evaluate whether or not to incorporate ESG and climate strategies into default funds, guidance could similarly suggest trustees consider whether or not they wish to allocate to private markets. Whether they do or not (and how) would of course remain a fiduciary decision.
“Cushon believes that guidance that helped refocus participants on good member outcomes over a narrow focus on cost (given the very significant cost reductions that have already been achieved) as the main driver of value, would help trustees allocate more to illiquid asset classes.”