The CISI are running an event.  Fans of Professor Sir John Kay are in for a treat on 15 July at the stunning Merchant Taylors’ Hall in the City of London.

I went to the Merchant Taylors’ Hall for the first time last night and impressive it certainly is.

Sir John will deliver the closing keynote at a major event on the Mansion House Accord — the initiative aiming to channel pension investments into UK businesses to drive sustainable growth. The CISI, in partnership with the Chartered Body Alliance and the Worshipful Company of International Bankers, is leading a key project to boost financial skills and knowledge to support this mission.

The Rt Hon the Lord Mayor Alastair King FCSI(Hon), who invited the CISI to convene the project, will also send his contribution in the midst of a very big day for the City and UK finance – the Chancellor speaks in the Mansion House that evening.

In the spirit of the debate, I’m publishing the questions put to members by the CISI and the responses from Iain Clacher and Con Keating  (in bold). Whether you are going or not, the deadly duo’s responses are well worth the read!

Questions answered..

In May, seventeen of the UK’s largest workplace pension providers committed to the Mansion House Accord’s aim of investing 10% of their default funds in unlisted assets by 2030, illustrating that change is on the way.

The Mansion House Accord (MHA), a successor to the 2023 Mansion House Compact (MHC), specifies that at least 5% of these investments should be in the UK, an element which is particularly contentious.

It should be seen as part of the Government’s agenda of increasing investment in the UK in “productive growth assets”, a term which they have left undefined. Our own definition would be: Investments is the capital structure (equity or debt) of taxable UK enterprises.

The choice of private investments is questionable at this time as PE returns have been falling, and the most recent boom area, private credit, seems likely to receive a performance set-back from the weak economic growth outlook.

The determination of the Government to achieve this objective may be judged from their inclusion of a new power to mandate investment asset allocation in the Pensions Bill currently before Parliament.

There remains a question as to why unlisted assets are the overall vehicle of choice and questions remain about the risk of these assets as much of what is discussed seems to sit much more at the venture capital end of the spectrum. VC is inherently much riskier, and it is not clear that this is where pension monies should be going. The failure rates of firms in VC portfolios are large; unicorns are called unicorns for a reason.

Where pension funds should be able to support growth at scale and help drive UK prosperity is through the provision of risk capital at listing via IPOs or through seasoned equity offerings. This will boost the LSE which has been stagnating and will help to keep innovative businesses in the UK while making London attractive to international businesses for raising capital.  

-What are the main benefits of the Mansion House Accord in your view?

It is undoubtedly true that a lack of private and public investment in the UK has contributed materially to the UK’s lack of productivity and economic growth over the period since the Global Financial Crisis. However, the MHA contains many conditioning clauses, get out of jail cards, according to some; notably:  a pipeline of UK investment opportunities, which the Government has agreed to facilitate.

The MHA could increase productive UK investment, though many of the signatories, such NEST, already have more than 10% of their portfolios privately invested.

The universe of private investments is far wider than the limited number of quoted UK companies, many of which have extensive overseas operations, thus offering the potential of greater diversification and wider exposure to the UK economy. Private investment is usually investment into the operating company, while the purchase of a listed equity or bond is merely a transfer of ownership. Listing is now predominantly a way for existing owners to ‘cash out’, rather an investment seeking to grow the activities of the company.

Will this be positive for the UK economy, as hoped? In what ways?

It is unlikely that the MHA will produce investment on the scale needed to impact materially the overall UK economy. It is though possible that competition among the investor signatories will reduce the potential returns available. At 5% of the signatories’ default funds, the MHA would currently deliver £25 billion for the UK. If default fund assets double by 2030, the date for implementation of the MHA, this would still only be £50 billion. By contrast, the Government’s “UK Infrastructure: A 10 Year Strategy” specifies proposed Government investment over that ten year-period of £725 billion. This seems likely to crowd out private sector investment over this period.

There is also a significant tension between changes to the tax regime in terms of corporation tax and employer NI, and the regime of capital gains. The cost of running and investing in a business is now higher, and many businesses bootstrap their investment rather than take on external finance. The capital gains regime has severely impacted the value that founders get when selling a business. Looking at the MHA in isolation from other changes is too narrow. The fundamentals need to be encouraging entrepreneurs to start, build, and grow their businesses, but this has been dampened, while those who would seek to scale and raise capital will likely look elsewhere as the realisation of value is likely to be more attractive in other jurisdictions. 

What are the challenges and potential downsides of the MHA?  Fee structures? Liquidity issues?

Liquidity is an issue in the private placement marketplace. In the noughties, the time taken for an investment to return that investment was around four years; it is now around nine or ten years. General partners have been unwilling to realise investments at prevailing market prices and a plethora of financially engineered “solutions’’ has emerged. Notable among these have been continuation vehicles. More recently, new partnerships have taken ‘Evergreen’ form – an expression so much more warm and cuddly than perpetual or undated.

While the MHA is concerned only with DC default funds, should this be extended to the legacy DB schemes’ assets, this liquidity concern would be far greater. DC provision is relatively new and growing, schemes are cash flow positive with new contributions far exceeding the trickle of pensions being paid, but private sector DB schemes are mature, and overwhelmingly closed, running down with pension payments far exceeding contributions and investment income.

Private placement fees have been much higher than the fees associated with listed investments, so that for many schemes the charge cap has been a barrier to investment in private securities. However, the MHA contains “alignment” between the Government and FCA on that framework, on the scope of the charge cap and clarity in rules and guidance, … subject to necessary safeguards”.  It is certainly true that in many cases the managers’ fees have exceeded the market cost of liquidity, which undermines any case of gaining a ‘liquidity premium’ from private investment.

The issue of fee structures and transparency is fundamental. Private market assets and private equity in particular have complex fee structures. If pushing for private market assets or even mandating them is the government’s objective, then doing this with no real understanding of the fees and no view as to a compulsory fee disclosure regime, is setting up future failure. Performance in the fund is what you get after fees. Investment in private markets and private equity is perfectly fine, but to make sure this works for savers, there needs to be clarity on the cost of performance. 

Is the uncertainty involved in investing in and valuing unlisted assets a concern? Why/why not?

Various polls of schemes and their advisors have indicated an unprecedentedly high acceptance of and desire to invest in private placements. However, this may arise from a lack of knowledge and understanding of the asset form. Most commitments are made to funds which promise to be created; there is nothing beyond the general partners prospectus promises to be analysed. (This is not true of established ‘Evergreen’ funds.) This blind investment raises issues for trustees of compliance with their fiduciary duty.

The meagre information flows on the performance of the individual investments which make up most funds are a concern. It really is necessary to employ auditors to value funds, but the vast majority of schemes seem to accept blindly the general partners’ net asset valuations. Indeed, the lack of valuation volatility is frequently (mis)sold by promoters as an advantage of private investment.

There is an interesting question as to the timing of the UK push into private markets. We have seen major endowments such as Yale are reducing their exposure to private market assets and venture funds, while there are stories most days about exit values and a lack of liquidity for exits. With the move from QE to QT and a significant increase in interest rates, it would seem that a market correction is due at some point. Timing the market is a fool’s errand, but jumping in when there are warning signs that all is not well is similarly foolish.  

What potential fiduciary problems could pension fund trustees face?

The principal issues will arise from the relative attractiveness of the (risk-adjusted) returns. In recent years, the UK has been internationally rather unattractive, much of which has stemmed from the rising labour share of national income, which has been further exacerbated by this year’s National Insurance changes and the increases in minimum wage – full time employees earning the National Living Wage will see an increase of £1,400.

Will experience in implementing 2023’s Mansion House Compact help with this? how different will the actions required be?

In terms of visible effects on scheme allocations as well as productivity and economic growth the MHC can only be described as a non-event. Indeed, if it had been successful, the MHA would have been redundant.

It is noticeable that the MHA states: “Crucially, this ambition is subject to fiduciary duties and the Consumer Duty and dependent on supporting actions by Government”. The FCA’s Consumer Duty Finalised Guidance (FG22/5) contains

“Principle 12 focuses on customer outcomes, and requires firms to; pro-actively act to deliver good outcomes for customers generally and put customers’ interests at the heart of their activities”.

Will pension savers benefit more from private market investment in the way that those in comparable schemes globally do (eg Australia) do?

In recent years Australia’s private sector productivity has been static and its public sector productivity has declined, a backdrop which makes overseas investment attractive; similar in many ways to the UK situation.

There is a tension between domestic and international investors in, for example, infrastructure investment. International investors can, and should, pursue a strategy of return maximisation; they need have no concern with the high future usage costs of the infrastructure. But that high future cost depresses future growth, from which the domestic scheme and its members might have otherwise benefitted.

This is a phenomenon which was widely seen in the use of PFI contracts. It remains to be seen whether the Government’s now preferred PPP (Public Private Partnership) structures can resolve these problems. It is surprising that that other methods of financing, such as land value capture, which financed much of the post-war New Towns development, are not being actively and extensively pursued. (Land Value Capture is effectively taxation of the windfall gains in land values arising from planning consent and infrastructure development.)

The read across from other markets to the UK is often reductive, ‘scale is good, private markets are good, look at Canada, look at Australia’. Nether of these statements are wrong. However, they miss the point that the scale journey in Australia started in the 80’s, while the private market investments in both Australia and Canada is a diversification play relative to their domestic economies. This is not to say the UK should not be doing these things, but the way in which they are discussed in policy ignores the timescales to achieve success, which is much longer than the life of a government, so for this to be successful, the diagnosis of the UK’s problems needs to be much sharper, the proposed remedies need to address the problems with clarity, and policy stability across governments will be needed. This is not something the UK has a good track-record of.

What are some of the things that will change in practice for CISI members (advisers/wealth managers) etc?

Little is likely to change materially in the immediate future. We note that some managers, such as Scottish Widows, have announced they are planning to cut UK investment in their high growth fund from the current 12% to 3%.

The greater concern should be if mandation is invoked and what the penalties for non-compliance would be, should that happen.

How might the experience of clients be different?

It is simply too early to tell. That Mansion House Accord requires implementation by 2030. There is still much uncertainty over detail in practice.

For example, even if mandation is imposed, it may be challenged: Article 1 of the First Protocol to the European Convention on Human Rights (part of English law through the Human Rights Act) concerns property rights. Broadly speaking, interference with property rights by the Government must be justified by the public interest and must be proportionate. Mandating investment in UK private assets would surely be interference. The further open question would then be what penalties will be imposed for non-compliance and how are these penalties distributed between pension savers and the managers of non-compliant funds.

The experience of clients will only emerge through time, and whether it has been a success will be reflected in the value of their pensions. The best outcome would be one where there is sustained economic growth, a replacement of crumbling infrastructure, and a pension pot at the end that will provide more than a meagre retirement. The uncertainty around being able to deliver this is to say the least, rather large.