The Chancellor of the Exchequer, Jeremy Hunt, has unveiled a new deal with some of the UK’s largest pension fund managers that aims to boost investment in fast-growing businesses and improve returns for savers. The deal, known as the Mansion House Compact, was announced in Hunt’s first speech at the City of London’s annual dinner on 10th July, 2023.
What is the Mansion House Compact?
The Mansion House Compact is a voluntary agreement between the government and the five largest defined contribution (DC) master trusts, which are pension schemes that pool the savings of multiple employers and members. The five signatories are Aviva, Legal & General, Mercer, Scottish Widows and Smart Pension, which collectively manage over £200 billion of assets and cover more than 15 million savers.
The compact commits the signatories to invest at least 5% of their default funds in private equity, which is a form of capital that invests in unlisted companies, often at an early stage of development. The compact also aims to simplify the listing process for companies on the London Stock Exchange and create a new trading platform for private companies that will open on specific days and will not require a public flotation.
Why is the Government Promoting this Deal?
The government hopes that by encouraging pension funds to invest more in private equity, it will unlock up to £50 billion of capital for UK businesses over the next decade, especially in sectors such as life sciences, fintech and green technology. These sectors are seen as key drivers of innovation, growth and job creation in the post-pandemic economy.
The government also argues that by diversifying their portfolios, pension funds will achieve higher returns for their members over the long term, as well as reduce their exposure to market volatility and inflation. Hunt said in his speech that private equity has historically outperformed public equity by 3% per year on average, and that UK pension funds are currently underinvested in this asset class compared to their international peers.
What are the risks and challenges involved?
However, investing in private equity is not without risks and challenges. Private equity is a highly illiquid asset class, meaning that it is difficult to buy and sell quickly and at a fair price. This can pose problems for pension funds that need to meet their cash flow obligations and offer flexibility to their members.
Private equity is also a very risky asset class, meaning that it has a high potential for both gains and losses. Investing in startups is especially risky, as very few of them become successful “unicorns” – companies valued at over $1 billion. According to a recent study by the British Business Bank, only 4% of UK startups reached unicorn status between 1998 and 2018.
Another challenge is the high fees and charges associated with private equity investments. Private equity fund managers typically charge an annual management fee of around 2% of the assets under management, as well as a performance fee of 20% of the profits above a certain threshold, usually 8%. These fees can significantly erode the net returns for pension savers over time.
How will this affect pension savers?
The impact of the Mansion House Compact on pension savers will depend on several factors, such as their age, risk appetite, contribution level and fund choice. The compact only applies to the default funds of the signatory schemes, which are the funds that members are automatically enrolled into unless they choose otherwise. According to Hunt, around 90% of DC savers are invested in default funds.
Default funds are designed to suit the needs and preferences of an average saver, but they may not be suitable for everyone. Savers who want more control over their investments can opt out of the default fund and choose from a range of alternative funds offered by their scheme. However, most savers do not exercise this option, either due to lack of interest, knowledge or confidence.
In Summary
Therefore, it is important that pension savers are aware of how their money is invested and what risks and returns they can expect. The signatory schemes have pledged to communicate clearly with their members about the changes to their default funds and offer guidance and advice where needed. Savers should also regularly review their pension statements and projections and seek independent financial advice if they have any questions or concerns.
The Mansion House Compact is an ambitious initiative that aims to boost investment in UK businesses and improve outcomes for pension savers. However, it also involves significant risks and challenges that need to be carefully managed and monitored. Savers should be informed and engaged with their pension choices and make sure they are comfortable with the level of risk they are taking on.
