The Mansion House Accord - What Does It Mean For My Pension Fund?
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Introduction
The UK government has recently unveiled the Mansion House Accord which is designed to unlock billions of pounds for the UK economy by investing pension fund money into private market investments.
There has been lots of commentary in the press and, in this article, I will set out what the Mansion House Accord is trying to do, what are some of the issues facing pension fund managers and what it could mean for your pension fund.
What is the Mansion House Accord?
The accord is a voluntary agreement between the UK government and, currently, seventeen of the largest pension funds to invest at least 10% of their defined contribution default funds in private markets by 2030 with at least 5% of this being invested in the UK.
What is a Default Fund?
If you are enrolled in a workplace pension and haven’t made an active decision to invest in a particular pension fund you are most likely in a default fund. These funds are designed to be suitable for the majority of people.
What does Private Markets Mean?
Private markets means investments that are not listed on a recognised stock exchange and can be shares, property, infrastructure and debt and/ or credit.
The Mansion House Accord is encouraging default funds to invest a relatively small proportion of their assets into these types of investments.
Why is the UK Government Encouraging Investment into Private Markets?
The government is seeking to support economic growth in the UK as well as improve long-term investment returns for pension savers by encouraging diversification away from more traditional investments such as publicly listed shares and government bonds.
What are the Investment Issues?
Private market investments are typically considered higher risk although their proponents argue that they offer the potential for higher returns over the long-term.
To evaluate these types of investment, it makes sense to apply some fundamental investment principles.
Diversification
It generally makes sense to diversify a portfolio across different asset classes that are not correlated to each other. In other words, when economic conditions negatively impact one asset class, they could benefit another asset class. Investing in private markets should provide a degree of diversification.
Time-Horizon
If you have many years before retirement, you should have sufficient time to ride out short-term fluctuations in the performance of the pension fund. Many default funds will apply a ‘lifestyle’ option whereby your pension fund is progressively moved from higher risk investments, for example, equities, to lower risk investments, for example, government bonds. It is likely that those nearer retirement will be switched out of any private market investments.
Liquidity
Private market investments tend to be relatively illiquid – in other words, these types of investments are harder to buy and sell. Given the size of the pension funds that have signed up to the accord and the relatively small proportion that will be invested in these types of investments, it would be envisaged that liquidity risk can be managed sufficiently.
Returns
This is what is causing some commentators to question the government’s strategy – does a higher risk investment necessarily produce a higher return?
It is perhaps a good idea to separate out the different types of private market investments as each will have different risk and return characteristics. Lets look at a few examples.
Infrastructure – large infrastructure projects will involve a large cash injection which, typically, will be backed by a large amount of debt. However, once built, infrastructure offers attractive returns especially if the asset, for example, a hospital, school or a supply of energy, is leased to a government-backed institution with inflation-linked increases.
Venture Capital – this is money that is used to help start-up companies or small businesses that are seen as having the potential to generate high levels of growth. By their nature, these are high risk investments given that a high proportion of start-up companies will fail. Having said that, one or two companies may provide stellar growth.
Private Equity – this is money that is used to acquire companies that are either unlisted or are publicly listed and then delisted once acquired. The intention is to inject capital to turn around the fortunes of the company and sell it later for a profit. The problem with assessing the returns on private equity is that it is often less than transparent, valuations can occur less frequently and often performance is self-reported by the private equity company.
Charges
The charges associated with private market investments tend to be much higher than those associated with regular collective investments such as unit trusts. This is because they require specialist managers to run the funds and the costs to identify, analyse and manage the underlying investments are much higher. Naturally, the higher the costs the more they will impact returns. However, it is important to bear in mind that there is a cap on the charges that can be levied by a default fund and this is 0.75% per annum. It will be interesting to see whether economies of scale can reduce the charges associated with private market investments.
Deal Flow
Increased investment in private markets is predicated on there being sufficient investment opportunities available. Whilst the government has promoted investment in infrastructure and renewable energy projects, it is difficult to know how they will ensure that there is sufficient opportunities for investment in venture capital and private equity that are suitably attractive.
What about Regulation and Oversight?
The wording of the Mansion House Accord is at pains to point out that the accord is an industry-led, voluntary initiative and, as such, pension funds won’t be mandated to invest in private market assets. In addition, the accord emphasises that trustees still have a statutory duty to act in the best interests of their members.
It is interesting to note that under the Pension Schemes Bill that has also recently been published, the government seems to imply that it could seek to enforce schemes to invest in these types of assets.
What Should You Do?
First and foremost there is no need to make any knee-jerk reactions – you should definitely continue to make contributions into your workplace pension.
Trustees of pension funds will still have a fiduciary duty to act in your best interests and, generally speaking, investments into a wider range of asset classes should be broadly welcomed. However, whether this will lead to improved investment performance remains to be seen and it might be several years before we know the full impact of the Mansion House Accord.
In the meantime here are some actions you should take
Find out where your money is invested – you can find this information on your pension provider’s website.
If you are nearing retirement or if you are looking to review your pension investment strategy, engage the services of a financial planner.
If you haven’t done so already, consider your overall retirement strategy. How much income do you think you will need in retirement and what needs to happen in terms of your level of contributions, to ensure your pension fund can provide that level of income.
Most people tend to ignore their pension and their wider retirement planning. Now might be a good time to take a closer look!
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If you would like to review your pensions or your wider retirement planning strategy, please do get in touch.
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