DC pension funds could benefit from investment into a “small but thriving” UK VC sector, but concerns remain about charges, and potential headwinds from DB schemes exiting the market.
Toby Nangle, an independent economic and financial market commentator, told delegates attending Corporate Adviser’s summit in Windsor that the data ‘broadly’ supported increased DC investment into venture capital, part of the private equity sector.
While he said he was “broadly supportive” of the Chancellor’s attempt to boost private equity investment, agreed with DC providers through the Mansion House compact, he pointed out that there were challenges ahead.
Nangle said that the UK venture capital sector, while significantly smaller than the US, was relatively strong in European terms and as big as the French and German market combined. This is also a highly tech-centric sector — with around 30 to 40 per cent of venture capital deal flow financing financial technology firms. This compares to the FTSE 100 which has almost zero exposure to technology stocks.
Nangle added that past performance data also made a strong case for increased exposure to venture capital. Globally, venture capital and growth equity outperformed public equity in each decade since the 1970s. In addition a survey of asset managers – including BlackRock, JPM, Morgan Stanley, SSGA and BNY Mellon – all forecast that private equity will outperform publicly listed equities over the next five to 25 years. “Asset managers seem to be in agreement that the sector has a rosy future,” he said.
However, while this makes a strong case for increased diversification for DC pension schemes, Nangle qualified this by pointing out that there were a number of additional issues DC pension scheme needs to take into account.
Critically was the impact of fees. Data from CEM Benchmarking, which covers 9,000 transactions from 1992 to 2020, found that while private equity had added value on a gross basis on average only larger investors using internal teams added value after fees, he said.
“This data suggests that private equity has been better for managers than for clients” he said.
As was pointed out by other speakers at the event very few DC pension scheme currently have the scale to have in-house private equity teams and will tend to invest through third parties and outside funds. This could ultimately impact returns.
Looking specifically at the dynamics of UK market, the defined benefit sector currently is one of the largest investors into private equity with an estimated £50bn in private equity and £80bn in commercial real estate.
With many of these schemes now seeking buy-out options this could see insurers shifting funds out of illiquid which could create some “unwelcome headwinds” for the sector. “This certainly won’t help the illiquidity premium” he said.
Nangle also pointed out that there was a lack of clarification about what the Mansion House Compact was aiming to achieve. While the compact specifically mentions private equity, Nangle said that he thinks the government focus is primarily on venture capital, and “addressing the bottle neck in venture capital funding that many UK businesses face when trying to scale up”.
As he pointed out the UK’s larger private equity sector — of which venture capital is a part — encompasses many older more established companies which may be looking for debt-financed buy-outs to take them out of public ownership.
Although the compact takes about “It is not clear that when the Chancellor says private equity he really means private equity. This wouldn’t necessarily solve the problem he is looking to solve, of addressing the UK’s low investment problem that hurts economic growth, he says. However he says this could be better addressed through improved VC funding, particularly at the later stage.
