Will pension funds now become big buyers of investment companies?
David Prosser on the victory for investment trusts in the Pension Schemes Bill.
The row over the Pension Schemes Bill in recent weeks has left something of a bad taste in the mouth. The UK’s biggest pension investors, who have already agreed with the government to increase their exposure to infrastructure and early-stage British companies, have felt aggrieved that ministers wanted legislation that would force them to act if they didn’t move far and fast enough. The government should not be able to override the fiduciary duty of trustees, many argue.
Still, with the bill now passed into law, let’s park that debate. The unfortunate thing about this argument is that it has got in the way of a discussion about the opportunities that private assets might offer. The potential for rewarding returns from these assets – for pension schemes but also for other investors – is very real.
For retail investors, an investment trust is really the most suitable option for securing private markets exposure.
David Prosser
Infrastructure, after all, includes the green energy networks that the UK must now build at a more rapid rate; it spans the digital systems we need to embrace technology transformation, and it covers the transport investment required to support economic growth. Early-stage businesses, meanwhile, will be the engine of that growth in the years to come, with the most successful companies offering outsized returns, just as acorns eventually grow into oak trees.
In that context, one last-minute amendment to the Pension Schemes Bill was definitely welcome. The government has agreed that investment companies can be part of the mix for pension investors as they raise their allocations to these private companies and infrastructure. A pension scheme’s holding in an investment trust that pumps money into, say, renewable energy production, will count towards its overall target for infrastructure exposure.
It’s a common sense move. Why shouldn’t investors who may lack in-house expertise in these areas turn to specialist fund managers who spend all day every day working on these private market assets? All the more so since the structure of an investment trust is the ideal guard against one big risk of infrastructure and privately owned companies – the closed-ended nature of funds eases liquidity concerns.
More broadly, this amendment is a reminder of the role that investment trusts can play in opening up access to asset classes once off-limits to all but the largest and most specialist investors. It’s not just pension funds who could benefit from owning these funds – many advisers also recognise the genuine opportunities here for their retail clients.
Indeed, for retail investors, an investment trust is really the most suitable option for securing private markets exposure. Funds in the Infrastructure and Renewable Energy Infrastructure sectors provide a direct route into those assets; Private Equity funds offer a way to invest in early-stage companies not yet listed on a public stock market. In an investment trust, retail investors and their advisers get access to daily dealing – they can buy and sell shares in the fund when they like – even though the underlying holdings may be illiquid and require large stakes.
How much exposure should advisers and investors aim for? Well, the Mansion House Accord, the voluntary agreement between the government and pension funds, commits the latter to allocating at least 10% of defined contribution pension scheme assets to private markets. For retail investors able to take a long-term view of their own holdings, that doesn’t seem an unreasonable allocation.
Interestingly, shares in many of the investment trusts active in these areas currently stand on wide discounts to the value of their underlying assets. In the Infrastructure sector, the average fund is on a discount of 13.5%, rising to 20.3% for Private Equity funds, and to 31.6% in the Renewable Energy Infrastructure sector.
There are various drivers of those chunky discounts, some of which will take time to address. But increased demand for the shares of these investment trusts would naturally help to narrow discounts, to shareholders’ benefit. That demand might now come from pension schemes as they seek to meet their Mansion House commitments.
David Prosser
David is former Business Editor of The Independent, Personal Finance Editor of the Daily Express, and Deputy Editor of Money Observer magazine. He writes regularly for the AIC.
