For the average saver, news that their investment returns will increasingly be from the private markets is akin to telling car-drivers that they are moving from 4 star (remember that) to unleaded petrol. So long as the pumps are primed then people will accept the change on the grounds that experts tell them it is best.
But if after switching to unleaded, you find the performance of your car falls off then you start asking questions about whether low-emission fuel is worth it. And if you find that instead of generating lower emissions, your new fuel is just generating bigger profits for the petrol companies, you get very upset.
I’m looking backwards and the forward looking analogy is the move to hydrogen and electricity, but I’m writing for an audience that probably filled its first tank with a fuel we wouldn’t use today. We can and should accept change, but the change needs to be for the betterment of society and the individuals in it.
Private markets in our pensions
At last week’s Professional Pensions Conference, I asked the Pensions Minister if he thought those that manage investments in private markets (private equity, seed and venture capital, private credit, social housing and infrastructure) whether these markets would adapt to the inflows of DC pension money by offering better value to the consumer.
Guy Opperman’s answer was frank and revealing. He told us that from his experience working with financial services providers, Government would need to intervene to ensure an equitable division of profits from private markets, too much being currently retained by those managing the investments.
I am of the same view, which is why I welcome a Labour party initiative to abolish the tax privilege accorded to private equity managers who can book personal profits from investing as capital gain (taxed at 28%) rather than income (taxed at 45%).
The argument is that the tax-break is a reward for investment managers taking personal risk. But Private Equity executives typically contribute between 1 and 3 per cent of a fund, according to lobby group the British Private Equity and Venture Capital Association. That amount is typically funded by non-recourse loans from the fund, meaning the investment risk to the manager is minimal. In short, the tax-payer is subsidising the lifestyles of very rich people out of the returns of investment of not so rich people. When those not so rich people end up being in workplace pensions (rather than the trustees of defined benefit schemes), scrutiny of what is going on , needs to be stronger.
Just over 2,000 people received £2.3bn in carried interest in 2017, equivalent to more than £1m each, according to research by the University of Warwick and the London School of Economics which used the most recent data available.
Taxing this as income instead of at the lower capital gains rate would have raised £440m, assuming the recipients paid the higher tax rather than left the country to avoid it, the report found.
If , as reported in the FT, Rachel Reeves, who is the Shadow Chancellor of the Exchequer, announces a Labour party campaign to abolish this ridiculous tax-break, I will support her, as I hope the Government will.
The inflows into private markets from the investment of our workplace pensions will hugely benefit those managing private market investments. But it is not a free-lunch for these fund managers, it is an opportunity for them to put aside their secretive and opaque image and come into the mainstream of investment management.
Taking away unearned and undeserved tax privileges is what Government should be doing through fiscal reform, but encouraging private market managers to adopt more open charging structures that do away with the complexities of the “carry trade” altogether, is what our big workplace pensions platforms should be encouraging. And the Government has the means to arm our workplace pensions with regulatory power. The FCA and TPR through IGCs and the Master Trust Assurance Framework, can now see what is being paid to manager our workplace savings.
Charges are the emissions of the investment management industry
What a manager takes out of a fund is akin to what an exhaust pipe emits into the atmosphere, a measurable output that does harm – either to our savings or to the atmosphere, or in some cases to both.
It may be that we can find a way to tax investment managers both on the amounts they extract as rents and by their capacity to reduce the toxicity of the investments they manage. I have nothing against rewarding Private Markets managers by their ESG results (provided we can find a consistent measure for doing so). This is proper risk sharing.
Proper risk sharing = proper reward
But rewarding Private Markets for their risk taking, where no risk is being taken, is not my idea of risk sharing. The deal is clear, we invest in private markets on our terms and if we cannot get reasonably terms from the managers, we need Government intervention. Let’s start by abolishing this historic tax loophole and then move on to more important matter.
We can move to private markets as we have moved to new forms of fuel, but we need to see the benefits of doing so!