Industry work on the treatment of performance fees within charge caps for defined contribution (DC) schemes is one of a myriad actions recommended by a group convened by the UK official sector to propose solutions to barriers to investment in less liquid assets.

Totalling 13, the actions underpin four main recommendations. In a statement, the Productive Finance Working Group referred to these as having a focus on “supporting DC pension schemes to invest and developing the long-term asset fund (LTAF) structure”.

It said the recommendations required action from industry and the official sector “and will create an environment in which defined contribution (DC) schemes and other investors can benefit from long-term opportunities”.

The working group is industry-level and co-chaired by the governor of the Bank of England, the chief executive officer of the Financial Conduct Authority (FCA) and the economic secretary to HM Treasury, the UK’s finance ministry.

Set out in a report published today, its four overarching recommendations are:

  • shifting the focus to long-term value for DC pension scheme members;
  • building scale in the DC market;
  • a new approach to liquidity management; and
  • widening access to less liquid assets.

The performance fee-related points were made under the heading of the first recommendation, and addressed both the industry as well as the Department for Work and Pensions (DWP).

In its report, the Productive Finance Working Group said that although recent DWP consultations about smoothing performance fees were a step in the right direction, “without more material reforms of how performance fees are treated under the cap, there is unlikely to be a material increase in DC scheme investments in less liquid strategies that typically incorporate performance fees”.

The specific action that was recommended for the industry was for the legal profession, asset managers, DC schemes and investment consultants to work together “in the appropriate forum” to consider “appropriate methodologies to accommodate performance fees within the charge cap, and appropriate terms and conditions more generally”.

A recommendation concerning the DWP, meanwhile, was for it, as DC schemes consolidated, to continue to consider how to reconcile performance remuneration and the charge cap rules.

Lack of consensus

According to minutes of a late July working group meeting, there was a lack of consensus within the group both on a proposal to exclude performance fees from the charge cap “where they are associated with greater long-term value for members”, and a proposal that the solution was for asset managers, consultants and DC schemes to work together to develop innovative and flexible methodologies for performance fees that are better suited to DC schemes.

The minutes reveal that the steering committee chairs agreed to continue to develop recommendations on those proposals with the aim of gaining greater support.

DC master trust NEST, which was on the working group, is currently searching for private equity managers, having challenged them to come up with a fee model involving an annual management charge and no carried interest.

Other more specific recommendations include for the FCA to consult on changing its rules for investment in illiquid assets through unit-linked funds and reviewing the LTAF distribution rules to facilitate wider distribution to “appropriate retail clients”.

A further recommendation is for the industry to develop, in collaboration with the FCA and the central bank, guidance on good practice for liquidity management at a fund level. The recommendation has to do with the fact that most DC schemes currently invest predominantly in daily-dealing funds, while investment in less liquid assets does not present the same daily dealing opportunity.

‘Launch pad’

Ruston Smith, chair of the Tesco Pension Fund and a member of the working group, said the initiative was “incredibly important to further improve the incentive and accessibility of good quality illiquid assets for UK defined contribution schemes and their members”.

”Further support from consultants and on trustee education, in this important area, will help provide good informed decisions and the further development of UK DC investment strategies.”

Richard Butcher, chair of the PLSA, which was also on the group, said its work and recommendations “will provide an important launch pad from which we can seek to resolve the detailed operational and systemic barriers that inhibit pension funds who wish to invest in productive finance and illiquid assets”.

“If we can succeed in this ambition, there is a real opportunity for a win-win here: an alignment of the national interest with the interest of pension fund savers,” he said, adding the caveat that it was “always important to recognise” that the UK pensions sector was not homogenous.

“Each fund will, by law, have its own prudently managed well diversified investment strategy and an approach designed to suit its members particular needs. And above all else, trustees’ primary duty is to look after the saver first,” Butcher said.

Guy Opperman, minister for pensions, welcomed the report, saying it was “essential” that all those appealed to – asset managers, pension schemes, regulators, and others – delivered on the recommendations ”so that savers benefit from productive investment”.

This article was updated after publication with the addition of comments from the pensions minister.

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