The importance of not simply selecting the default fund option in a workplace pension is a message that needs to be shouted far and wide
The government-owned British Business Bank has called on defined contribution pension schemes to hold more adventurous investments and become less cautious.
The British Business Bank, which provides credit for small- and medium-sized British companies, has urged pension schemes to increase exposure to venture capital and growth equity – small, fast-growing UK businesses.
On the one hand, given the long-term nature of pension investing, allocating capital to small companies with aspirations to grow into large world-leading businesses could be viewed as a good fit.
But the trade-off that comes with backing young businesses is that by their very nature they are high-risk investments. Moreover, investing in illiquid assets will always create some liquidity risk – something the report acknowledges.
The importance of not simply selecting the default fund option in a workplace pension is a message that needs to be shouted far and wide.
The reality is that for most pension schemes the default option for most is likely to be some form of balanced multi-asset fund, which will have been automatically selected by a pension firm for being the ‘safe choice’.
The irony, though, is that while the fund is unlikely to fall like a stone over a short time period, over the longer term those in their twenties or thirties can afford to take on more risk, given the ample time on their side. A balanced fund will typically have 40% to 60% in global shares, but those with a 30- to 40-year time horizon can be much more adventurous.
To date, allocations to venture capital and growth equity have been low, but the British Business Bank says that a small allocation of 5% could provide a big boost to a pension over a 30- or 40-year timescale.
The report notes that retirement savings for the average 22-year-old could be increased by as much as 7% to 12% if schemes made a small allocation to venture capital and growth equity investments.
Even for older workers, the potential increase in returns could be significant, the report adds. It says that a 35-year-old with £25,000 currently invested in retirement savings could see a 6% to 10% increase in their lifetime retirement savings, while a 45-year-old with a £50,000 pension pot could see a 6% to 7% increase.
Keith Morgan, chief executive officer of British Business Bank, says: “The aim of this study is to enable better long-term retirement outcomes for the UK’s defined contribution pension savers with a focus on commercial solutions that could be implemented in the private sector.
"It is incumbent on defined contribution pension schemes to consider how to include investments in the UK’s fastest-growing and most innovative companies.”
The Association of Investment Companies (AIC) has backed the proposals. Ian Sayers, chief executive of the Association of Investment Companies (AIC), says: “Investment companies have an important role to play in helping pension funds transform the retirements of savers, in particular younger adults, by investing in the growth companies of the future.
"Investment companies have a proven long-term record of investing in private equity, growth capital and venture capital. The Business Bank has rightly recognised that investment companies are highly suitable for this purpose.
“The report also highlights some of the challenges that arise when making regular investments into illiquid assets, and the need to ensure fairness among scheme members. The closed-ended structure addresses many of these concerns.
"The stock market provides high levels of transparency and liquidity, and ensures that the price reflects the latest information about valuations and the stage of development of the portfolio companies. This means that investors entering or leaving the fund do so at a price set independently throughout the day.
Legal & General also welcomed the findings. Nigel Wilson, chief executive officer of Legal & General, commented: “The UK has some of the best universities in the world, which are fuelling innovative, commercial ideas, including artificial intelligence and data-driven businesses, as well as scientific breakthroughs.
"However, the innovative companies at the forefront of this disruption are now staying private for longer, delivering returns to a small group of private market investors.
“We welcome the findings of today’s report and look forward to rising to the challenge laid down by the British Business Bank by delivering a viable solution for defined contribution clients which democratises access to this important asset class.”
This article first appeared on our sister website Money Observer