Toby Nangle has written in the FT about the Chancellor’s bet on private equity as a means to improve people’s pensions. You will remember that the Chancellor promised us, in his Mansion House speech, £1,000 pa more in retirement, if we let our savings pot have 5% invested in high-risk assets that paid more over time.
Nangle says that the idea solves two problems, providing capital to parts of the UK economy that are starved of it and offering pension savers the kind of investment returns that institutional investors are able to get, investors like the Local Government Pension Schemes and endowments like Wellcome Trust.
But there is a third problem, which DC savers cannot solve for themselves, that is a problem of scale , which cannot be achieved through buying funds on SIPP platforms or relying on investment pathways. We need to come together to assert our collective buying power. This theme is consistent to all the papers that followed Monday’s speech, especially the consultations response to the VFM Framework, the papers on CDC and retirement choices and the call for evidence on small pot consolidation.
And this scale is needed to get the returns in the Government’s assumptions for growth in our retirement incomes
People will get bigger pensions through saving more, investing better and drawing money down more efficiently .
The claims for better pensions from the shift to private equity is much more modest than Hunt made it sound, the 12% increase in retirement income comes from the package in table 8, not just from the shift to private assets in our saving.
And as Toby Nangle writes in the FT, the 3% uplift from private equity is not based on heroic assumptions.
These are the fee assumptions used by the Government in their projections
GAD assume equities/bonds face fees of around 0.25% per annum. For
Private Equity, it was decided a reasonable assumption was 1% per annum and
further performance fees of 10% for returns above 8%. This is for example, due
to the range of risk and return objectives of Private Equity funds and anticipated
increased scale of investment in Private Equity by DC schemes, meaning it is
likely some schemes may be able to negotiate competitive fees.
However, we recognise a fee structure of 2% per annum for Private Equity (and further
performance fees -20% for performance above 8%)) is a common charging
structure across the Private Equity industry and has been used by DWP when
considering the recent Pension Charge Cap reforms
The DWP’s modelling shows a range of outcomes over time which are dependent on the fee structure negotiated by a pension fund. You can see the entire modelling by downloading the Government analysis
But the FT have handily condensed the results into one chart that shows that the 3% uplift from an allocation to P/E is based on the average fee structure and what Nangle finds reasonable
But inspecting the fine print, the government costings analysis does not rely on heroic return forecasts. In fact, they project that defined contribution pension pots will be slightly smaller if they make the switch from public to private equity, once fees are taken into account.
The fees are substantial, with a 5 per cent allocation to private equity more than doubling their cumulative total paid over 30 years in the median projection from £10,700 to £22,500 per pension saver.
As such, Hunt is forced to rely on a supplementary forecast in which private equity firms charge UK pension managers only half their standard rate to clear his “golden rule” of securing the best possible outcomes for pension savers
The consolidated chart shows that there is a “saver’s sweetspot”. Where PE makes them most money is when Private Equity managers fees are halved and where performance fees don’t crash the party.
You might well ask , why manager fees can mean that when “upside is high” (right hand) savers get less than if upside is average (centre case). I struggle with the logic too, so does Professor Ludovic Phalippou of the Saïd Business School has who called the private equity industry a billionaire factory, where the billionaires are the fund managers rather than the entrepreneurs.
Clearly much work is going to need to be done to get savers a fair deal on fees. In an article in CityWire’s New Model Adviser, Chris Sier warns
To play with private equity, the starting point is [fees of] roughly 3% to 4% of assets a year,’
‘If you are a defined contribution [DC] pension fund, it’s going to cost you a lot more than that because of the capital cost to set the fund up and the liquidity cost to manage the “in and out” mentality that retail consumers have when investing in things. The government’s assumptions are wholly undercutting it in terms of the base cost of private equity.’
Currently DC pensions don’t invest in private equity because not only do the fees make them uncompetitive in a price-driven market, but because the numbers for savers only stack up if deals can be done at half the current price charged by the managers.
The chancellor’s desire to help crack two hard problems — the difficulty that companies have scaling up from start-up to listing, and low prospective defined contribution pensions returns — should be applauded. If he can force down private equity fees to a level where the asset class outperforms public markets even in a higher yield environment he will have cracked a third.
It is hard to disagree with him.
The Mansion House reforms are a package , of which the 5% allocation to PE for DC workplace pensions, is only a part. Ironically , the headline is now hiding the meat of the package, the benefits of better purchasing using VFM rather than price, improving the contributions and efficiency of auto-enrolment and a shift from individual to collective decumulation.
The Chancellor sold it that way and he will have to live with the consequence of simplifying his message. Moira O’Neill isn’t the first and won’t be the last to publish self-help guides to those who are spooked by “Hunt’s risky plans”.
I expect the “Compact” will find a way to halve private equity fees. Meanwhile, we should focus on the Reform Package and proposals which while not so newsworthy, are probably more important to us pension savers.