The number of listed companies is in decline in the UK, France, Germany and the US. Exciting young companies are opting to come to market only when their best phase of growth is over. And investment in private markets is rising fast, from $3.9 trillion in 2014 to $5.8 trillion last year.
These trends are important for pension savers, because they may not be getting enough exposure to the companies that will generate most growth in the future. A report from the British Business Bank highlights that defined contribution (DC) pension schemes have significantly less allocation to unlisted alternatives than defined benefit (DB) schemes. Given that DC schemes will largely replace DB schemes, this has worrying implications.
Exposure to private markets, such as venture capital and growth equity, has been shown to increase long-term returns. The British Business Bank’s analysis of investor returns between 1970 and 2016 shows venture capital (VC) and growth equity (GE) delivered annualised returns of 18%, compared to 11% for the MSCI World Equity Index. If only 5% of DC scheme assets are allocated to VC/GE, the average 22-year-old could achieve an increase in retirement savings of between 7% and 12%.
So why aren’t DC schemes doing this? One problem is that the dispersion of returns in VC/GE is much higher than for conventional assets. Broad diversification is essential – and DC schemes interviewed for the study indicate that they would prefer to gain exposure through a pooled vehicle. Another barrier is that the costs of private equity investing are higher than most DC schemes can stomach. Last but certainly not least, there’s the need to treat all scheme members fairly when investing in assets that are illiquid and hard to value.
A listed closed-ended fund (such as a UK investment trust) ticks many of these boxes. The listing provides liquidity and transparency, while the fund’s investment strategy is not put at risk by untimely redemption requests. A further advantage is the independent board of directors, which can enhance governance and negotiate the best fees for shareholders. There is no need to reinvent the wheel: investment trusts have a proven long-term record of investing in private equity and venture capital.
One commonly cited drawback of a closed-ended structure is the prospect of deviation between the share price and the net asset value of the underlying holdings. An open-ended fund can, in most circumstances, offer purchase and redemption at NAV. However, the collapse of the Woodford Equity Income Fund has demonstrated that redemption at NAV is far from guaranteed when open-ended funds hold illiquid assets. Bank of England governor Mark Carney acknowledged this when he warned that such funds were “built on a lie”.
Whatever the fund structure used to access private markets, this growing field of opportunities should not be ringfenced for the exclusive benefit of endowments, family offices and high-net-worth individuals. Ordinary pension savers, who may have multi-decade investment horizons and are almost certainly not saving enough for their retirements, could benefit from modest, professionally managed exposure to fast-growing unlisted companies – and the wider economic benefits of such investment could pay dividends for the taxpayer too.
Nick Britton is head of intermediary communications at the Association of Investment Companies
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