Much has been made of the UK’s pension schemes bill — now law — as it made its move through the parliamentary process. It promises to steer and influence how billions of pension assets are deployed across the UK economy.
One of the most significant developments is the government’s intention to reshape the framework for productive finance investment and make it wrapper agnostic.
This represents a move away from the earlier drafting that in effect shut out listed closed-ended investment companies from pension portfolios. The latest move has been heralded as a step forward for the investment company sector and a potential major new source of investment.
While encouraging, our view is that the outcome is likely to be more nuanced.
Private exposure
Investment companies have long invested in private assets. However, the initial draft of the bill prevented pension schemes from utilising listed closed-ended investment companies to access private assets, including venture and growth capital.
This decision was made despite the British Business Bank and management consultancy firm Oliver Wyman both reporting investment companies as having “high” suitability in terms of pension fund investment.
The Association of Investment Companies led the way in arguing that the decision was driven by the preferences of large pension scheme signatories of the Mansion House Accord, rather than by the evidence.
These large pension schemes often prefer to create their own captive vehicles, including long-term asset funds (LTAFs), over the use of existing closed-ended investment company structures.
Reaching a compromise
After a period of intensive lobbying and several House of Lords amendments, it appears that parliament has sought a path of compromise. The new revised framework includes closed-ended investment companies and real estate investment trusts (Reits).
They now qualify for pension investment based on their ability to provide exposure to productive finance such as infrastructure. The bill has been revised to focus on the quality and nature of the underlying assets, rather than the structure used to hold them.
The benefits of pension funds investing in trusts
The argument for investment companies is strong. The structure provides permanent capital to help fund businesses and infrastructure, without the need to sell down holdings to meet redemptions. In comparison, LTAF structures can be forced to sell private holdings to meet redemptions, often at points of peak market volatility. This in turn can potentially reduce the quality of the underlying portfolio for the remaining investors.
As pension schemes broaden their private assets exposure, there is merit in including stock exchange-traded investment companies, offering daily liquidity, to help mitigate some of the recognised risks around the less frequent liquidity offered by LTAFs or traditional private fund programmes.
This should not be viewed as a zero-sum game. The inclusion of investment companies in portfolios, even at the margin, could offer pension schemes liquidity in times of market stress.
Could this move benefit investment trusts?
The investment company sector has been buffeted in recent years by the effects of a consolidating wealth management sector and increased activism, but any hope this development could be a panacea is probably overstated.
For one, the government has repeatedly said it does not intend to use the productive finance mandate, a reserve power, unless the pension scheme industry fails to embrace the initiative.
Many, including the Conservative Party, have argued that the government’s power to mandate investment in productive assets could interfere with pension scheme trustees’ duty to act in the best interests of their members. There is also the outlying risk of future governments using the power in a manner not originally intended.
Even the governor of the Bank of England has expressed concerns around the broader mandate, cautioning that any intervention could serve to undermine the independence of pension trustees and distort markets.
There is also the question of scale and market liquidity. The government’s ability to mandate how DC pension schemes invest is limited to no more than 10 per cent of the total assets held in default funds, with no more than 5 per cent in UK-based assets.
For this to materially benefit closed-ended investment companies, they would need to attract a meaningful share of that constrained allocation while competing against LTAFs, in-house vehicles that the major DC schemes are building, and direct co-investment platforms. Even if successful in capturing allocations, many investment companies may struggle to offer the liquidity required to absorb material deployments.
Ultimately, will trustees opt for trusts?
The structural advantages of investment companies are clear: daily liquidity for investors, a long track record of investing in private assets including infrastructure, price transparency, protection from redemptions, and independent governance. But it remains to be seen whether pension scheme trustees will actively consider investment companies over structures they retain more control over, especially the mega-trusts the bill is designed to create.
Ultimately, the bill hopes to boost investment in UK productive assets by accelerating the consolidation of smaller pension schemes into a smaller number of larger funds with the wherewithal to invest meaningfully in longer-term assets. In theory, investment companies are now part of the suite of options available, but much rests on the sector’s ability to promote its case, demonstrate ongoing performance and its ability to compete on cost.
The move to a wrapper-agnostic stance is a significant development for the investment company sector, but it doesn’t necessarily guarantee success.
David Harris is managing director at Cadarn Capital, a fund distribution and investor relations group that advises investment trusts