ASSET ALLOCATOR SPOTLIGHT

The Mansion House Reforms, Private Equity and DC – The Devil is in the Detail

By Mark Austin | November 2023
Pensions and Insurance Executive, EMEA

A few weeks ago, I attended the Mansion House Pensions Summit along with many colleagues from the UK pensions industry.  We were there to discuss how the UK government’s proposed reforms to the country’s pension industry could work in practice.

Back in July, the UK Chancellor presented a series of new reforms seeking to reignite growth in the UK – amongst others by unlocking capital held by UK pension funds to invest in high-growth sectors in Britain.   This includes an industry led compact committing many of the UK’s largest Defined Contribution (DC) pension providers to the objective to allocating at least 5% of their default funds to unlisted equities, such as private equity and venture capital,  by 2030¹.

In a speech to the City of London this summer, UK Chancellor, Jeremy Hunt, contrasted the exposure to unlisted equity by UK pension schemes, at less than 1%, to the exposure of Australian peers, at 5-6%².

The UK has a booming biotech and life sciences sector that is always thirsty for more funding. Long-term pension capital could also be readily deployed in innovative green energy and media. Then there is a burgeoning fintech sector, with the  government keen to incentivise companies to start and grow in the UK by strengthening London’s position as a listing destination.

But the mechanisms of Defined Contribution (DC) pension schemes in the UK need altering in order for capital to flow to native start-ups. The number of Private Markets strategies structured for the DC market are few and far between. One block has been the norm for investment funds serving this market to be valued daily. That clashes with the illiquid nature of private equity, and especially innovative venture capital. There are ways round the problem, such as including illiquids in a multi-asset strategy and relying on other, highly tradeable elements to both permit daily dealing and approximate total valuations.

Long Term Asset Funds (LTAFs) are likely to be the vehicle that brings Private Markets to DC (and the wider retail market in the UK). The first one was registered in March 2023, so these are early days. If LTAFs are to better marry outcomes for DC investors with greater financing of UK-based entrepreneurs, they will have to gain acceptance as default offerings. As in other countries, default funds capture the lion’s share of assets in the UK DC market. However, there is a price cap, currently 0.75%, on default funds. Including just 5% exposure to Private Markets investments might not strain the cap, but it is a consideration for those deciding to allocate assets to LTAFs³. This is a challenge that is additional to the liquidity challenge that arises from the daily dealing requirement which is still not fully addressed by the LTAF structure.

The next challenge relates to size. The largest providers in the sector are already on board as signatories to the Mansion House Compact, wherein they have pledged to show demonstrable action in the next 12 months. However, for the long tail of occupational DC plans, this may be yet another pressure to consolidate. The number of schemes fell by almost 40% between 2011 and 2021 and the UK government clearly wants that trend to continue.  The question then arises, if a plan is looking at a transition to a Master Trust, will they look at Illiquid assets first?.

One reason Australian pension funds have 5-6% on average allocated to Private Markets is because retirement assets there are concentrated in a small number of providers. The Australian regulator said in 2021 that funds with less than A$30bn were “uncompetitive.”⁴ Only three DC Master Trusts in the UK surpass this threshold, although others are growing fast.

Whether they all make outsized returns from greater allocations to Private Markets remains to be seen. The UK government’s material on this new policy refers to unlisted equity as ‘high growth’. In the world of investing, most high growth opportunities are also high risk. Trustees of UK pension schemes are now on a steep learning curve to educate themselves about the many different opportunities, from direct lending to venture capital. Since October, fiduciaries of DC pension plans have had to declare whether they have illiquids in the default fund, and if so, why. In terms of hastening national policy, this demand is a good thing.

The new regulation, however, does not specify UK-based illiquid investments. That may be where pension fund investment and national policy diverge. Institutional investors, if they are to discharge their fiduciary duty, will look at the full ambit of opportunities globally. That could entail no more than a proportionate contribution to the UK economy. It will support the global trend of retirement plans allocating more to private markets but might not meet the Chancellor’s aims.

There is general recognition of the potential opportunities that the reforms could bring - and yet also that there are many considerations to be worked through with the devil being in the detail. 

It will be key for the industry to come together to make sure the right product is created, with the right liquidity, in the right place for the pension scheme members.

¹ Mansion House 2023 - GOV.UK (www.gov.uk)
² Chancellor Jeremy Hunt's Mansion House speech - GOV.UK (www.gov.uk)
³ The charge cap: guidance for trustees and managers of occupational schemes (publishing.service.gov.uk)
⁴ APRA labels 90pc of super funds ‘uncompetitive’ (afr.com)

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