“How productive is productive capital?” – Keating and Clacher

On 30th November 2021, the Government announced a further consultation on “Enabling investment in Productive Finance“. This article is the response to that consultation by Con Keating and Iain Clacher.


This consultation comes just a few months after the modification of the charge cap and is a proposal to exempt certain classes of illiquid[1] private investments from the DC charge cap.

Specifically, the government proposes adding to the list of charges currently out of the scope of the charge cap to include well-designed performance fees that are paid when an asset manager exceeds pre-determined performance targets.

The title of this consultation is misleading to the extent that it is concerned solely with illiquid securities and the DC charge cap. Far more investment in productive finance and capital lies outside that limited range of instruments, and it is worth emphasising this at the start as the scope of the consultation is extremely narrow.

We have in this response considered the investment merits of illiquid securities and their potential use in DC pension arrangements but have omitted, as being out of scope, several other important public policy aspects, such as consideration of the tax cost of these partnership arrangements and the economic consequences of material increases in the indebtedness of the corporate sector.

We would also note that the BIS[2] has recently begun work on some public policy aspects of private markets, such as procyclicality and monetary policy transmission sensitivity all of which are clearly relevant to this issue.

To provide context, we commence with a brief discussion of the Ministerial Foreword to the consultation. We share the Minister’s ambition “…to ensure optimal outcomes for the nation’s defined contribution (DC) saver” but do not believe that the proposed changes would or should contribute to achieving that.

The foreword states: “The trustees of DC schemes are increasingly looking to private markets to deliver on this responsibility due to the benefits of diversification and greater returns.”, which we do not believe is unconditionally true, and except for a small number of high-profile larger schemes, there is little evidence presented thus far that there is significant pent-up demand by the trustees of DC schemes for these types of investments.

It seems to us that the exhortations and inducements of the Prime Minister and Chancellor in their open ‘challenge’ letter[3] have been the driver of this interest. We (Keating) wrote and published an article in response to that challenge.

In the course of our responses to the specific consultation questions, we will challenge some of the general statements made about these asset classes that are taken as accepted wisdom e.g., the idea that these investments are truly long-term in nature, offer any materially better diversification or greater returns than conventional listed investments.

The foreword asserts: “Investment in asset classes like green infrastructure, private equity, and venture capital, fits well with the long-term horizons of DC schemes.”.

It is true that the illiquid investments, typically limited partnership interests, that investors are required to make are contractually long-term in nature, typically having a lifetime of ten or fifteen years, but this does not mean that the investments made by these partnerships are long-term – and it is that, of course, which must ultimately be reflected in the performance of these partnership funds.

According to Pitchbook[4], the average term of investments held by private equity firms is now 4.5 years, up from 2.2 years in 2006. In 2016, the most recent year reported by Pitchbook, 31.2% of companies exiting buy-out funds had been held less than five years, down from 50.9% in 2003.

With distributions to investors currently at 28.8% of net asset value annually, funds have a life, or term, to return the initial investment of just 3.47 years. Note that both traditional listed equity and corporate bonds have lives far in excess of this term. With the FTSE dividend yield at 3.2%, listed equity has a 31-year term, which share buybacks would bring down to around 27 years.

The investor in a private equity fund does not know when or for how long the funds committed will be drawn. Figure 1 shows the most recent levels of undrawn capital, the so-called “dry powder” currently sitting but undeployed in PE.

Note that there is uncalled but committed capital dating back as far as 2013. Moreover, this total is large by comparison with calls on committed capital as is indicated in Figure 2.


This stock represents almost four years of supply based on the highest level of contributions (investments) made (~£70 billion) in recent times; at the lowest rate it has been over seven years’ supply and is equivalent to over four years of new fund raising.

The distribution amounts arising from the realisation of investments made are also highly variable from year to year. For the US private equity market, they have varied from as little as 5% of the net asset value of funds to over 45%.

This is the source of much confusion as to achieved rates of return. The internal rate of return (IRR) is based upon the funds deployed over the period to the realisation of the investment and not on the total amounts of capital provided.

The investor knows neither when nor for how long the funds committed with be required.

Figure 2: Contributions and Distributions – UK Funds

As Table 1 shows, there is a further challenge for venture capital funds; their reported gross internal rates of return decline markedly as the holding term increases.

Table 1
Term (Years) 5 10 15 20
Reported Gross IRR (%) 18.46 15.18 11.75 8.03
Equal Weighted (%) 15.89 13.63 10.55 6.66

Source: Pitchbook. (USD returns)

As the total returns achieved by year fifteen are larger than those achieved by year twenty, it would make no sense to hold these funds beyond the fifteenth year.

These facts with respect to investment term contradict the claim of goodness of fit to DC pension term. More importantly, they challenge the private equity industry’s claims that excess returns may arise from the long-term nature of private equity investment.

As ‘green infrastructure’ is a new investment classification there is no historic record or empirical evidence on which to base its expected behaviour. There also is no shortage of capital to invest in this area – at least where the risk/return profile is economically attractive- see the further discussion in the House of Commons Work and Pensions Committee ‘Pensions stewardship and COP26’ Report published on 30 September 2021 at Chapter 4[5].

UK Private equity investment flows have been around £40 billion in recent years; this is more than twice the amount raised by IPOs in the London listed markets (£17 billion).

Slightly over half of the funds raised in the London market were paid to prior shareholders, with the balance (£8.3 billion) being used for new productive investment. Almost all of the flows from private equity were to prior shareholders.

The correct comparator for this £8.3 billion is, perhaps, the amount raised as venture capital (£13.3 billion) – Figure 3 shows the distribution of VC funding by stage of investee company development. Note that £6.8 billion of this investment came from US venture capitalists. Few of these VC funded companies could justify the expense of obtaining a listing – the benefits of liquidity to them and their shareholders simply do not exceed the costs of providing it.

Venture capital is of course new private investment and if successful will be productive, but it is important to realise that most private equity is not an investment in the firm. The investment is paid to selling shareholders, and there is no new investment in the firm. If this transaction is to increase productivity, it is the investments made by the sellers which will determine this.

Figure 3: Venture Capital Funding by Stage

The foreword continues with:

Such investments have the potential to provide better returns for members as part of a balanced portfolio and help to sustain employment, our communities and the environment.

Indeed, we might say that any socially responsible investment would help sustain employment, our communities, and the environment – these are not unique properties of private equity, venture capital, or other private markets. There are many who would challenge the idea that private equity is unconditionally good for employment or the communities in which they operate.

There are all-too-many instances where the private industry’s behaviour has proved rapacious e.g., the case of Debenhams when it was first delisted, restructured, and relisted. While these investments may have the potential to provide better returns, we will examine later the question as to whether they have in fact achieved this.

Here we will simply note that the pricing formulations for these investments lead to understatement of risk and price volatility and lower correlations with market-priced assets.

The true relative price volatility of venture cap funds can be estimated by the dispersion of reported returns across funds – the standard deviation and top to bottom decile values of reported fund returns for the past five years is shown in Table 2.

The dispersion of private equity fund returns is twice that of the MSCI world equity index (27% versus 14%).

Table 2  
  Global VC 2020 2019 2018 2017 2016
  Standard Deviation % 61.99 52.98 30.65 20.57 25.86
  Inter-Decile Range (%) 119 129 64 50 37

Source: Pitchbook, Author’s calculations

We offer further evidence on the reliability or otherwise of fund valuations later. With these ranges of returns possible, the selection of fund is critical. Indeed, these ranges of returns suggest that it is inappropriate to think of venture capital as a homogenous asset class. It is to be expected that investment advisors will naturally take this opportunity to levy further fees for selection advice, a cost which is borne by the scheme and ultimately employers and scheme members.

There is some disagreement as to the asset allocation of DC Funds. The Oliver Wyman/British Business Bank paper reported 74% in equity as shown in Figure 5.

Figure 5: The Oliver Wyman/British Business Bank

By contrast, the ONS reports figures as shown in Figure 6:

Figure 6: DC Asset Allocation (ONS)

The allocation to private equity is zero. The maximum allocation to equity, which would require all of the mixed-asset portfolio category to be invested in equity, is 64%.

Though DC schemes overwhelmingly hold funds rather individual stocks or segregated portfolios, these equity exposures are the most volatile of their exposures; this reflects their considered risk appetite.

If they are to maintain this risk profile while introducing say 10% of venture capital into it, they would need to sell almost 20% of listed equity and invest the cash difference in low-risk secure assets (and hope that they achieve median risk and return characteristics in the chosen VC fund(s).

Of course, it is possible that DC schemes have some exposure to private equity or venture capital through holdings in the listed investment trusts specialising in private investment. Appendix D shows the performance of a selection of these.

It should be understood that the overall distributions of private equity portfolio returns do not have a suitable return profile from the perspective of a pension fund. Only a small fraction of venture investments has stellar performance and far more fail abjectly. These characteristics are more akin to those of a lottery – few winners and many losers. This is unlike listed market equity where a low-cost index tracker can be purchased, and so while some firms will inevitably fail, stellar performers can be picked up without the same risk profile or cost base e.g. Apple, Microsoft, Amazon, Google, and Facebook (Meta).

To illustrate this point, there are currently 186 venture capital-funded enterprises with ambitions in the field of satellite rocketry; it is estimated that, when mature, this field will consist of no more than twenty large firms. In fact, the history of technological and industrial developments suggests that this estimate may be high (think pharmaceuticals or automobiles).

One might say that the rewards to the winners will be stellar while those failing will disappear into a black hole. This results in a markedly asymmetric distribution of returns; the median return lies far below the mean return; the financial effects of this may be judged by the difference between the reported results and an equally weighted portfolio of the assets; the lower row in Table 1 above. With this risk and return profile, most investors will not achieve the mean or average return.[6]

The foreword also considers the publication of the final report of the Productive Finance Working Group to be a

“…significant step towards addressing the barriers to investment in long-term illiquid investments for government, regulators, and industry.(Emphasis added).

The members of the working group are shown below. In our initial response, which pre-dated the publication of this report, we cautioned against the weight of lobbying from the vested interests of the financial services lobby, but this group is heavily biased in that direction, and of course, with the position of the Prime Minister and Chancellor known, it was politically expedient to favour the inclusion of illiquid investments such as private equity.

Members of the Working Group  
ABRDN London Stock Exchange Group
Association of British Insurers Macquarie Group
Association of Investment Companies NEST Corporation
Alternative Investment Management Ass. Partners Group
Aviva Pensions and Lifetime Savings Association
BlackRock Rothesay
BNY Mellon Simmons & Simmons LLP
British Private Equity and Venture Capital Ass. The City UK
Fidelity International The Investment Association
Hargreaves Lansdown Universities Superannuation Scheme
HSBC Willis Towers Watson
Impax Asset Management Independent Trustees of Pension Schemes
Legal & General Group (Ruston Smith, Paul Trickett)


The co-chairs of the working group included John Glen MP, Economic Secretary to the Treasury

It is interesting that there are no employer or employee representatives in the working group membership, nor does there seem to be any independent observers, who have been used before in other similar industry working groups e.g. The Institutional Disclosure Working Group of the FCA.

Of the 19 organisations represented on the Working Group 14 have a clear financial interest (or their members do) in the lifting of the charge cap. The optics do not look encouraging – another case of the financial services sector profiting from the hard-earned retirement savings of pension scheme members with no downside risk. Why would they not recommend lifting the charge cap?


[1] The consultation and its various supporting reports refer to an illiquidity premium when it is liquidity which has a cost. If a fund is acquiring liquid assets, it is paying on purchase the then-prevailing liquidity cost, and there can be no excess return to the fund. In general, whether a non-traded fund earns an ‘illiquidity premium’ is not a matter of its structural negotiability, but rather of the liquidity costs paid on the assets which it has acquired.

[2] https://www.bis.org/publ/qtrpdf/r_qt2112.pdf

[3] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1008814/A_Challenge_Letter_from_the_Prime_Minister_and_Chancellor_to_institution__1_.pdf


[4] https://pitchbook.com

[5] https://publications.parliament.uk/pa/cm5802/cmselect/cmworpen/238/report.html

[6] It is worth highlighting that the equally weighted nominal return of 6.6% before fees from this asset class really does not compare well with the equivalent 6.2% real return achieved by listed equity.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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