On 17 January 2022, ShareSoc and UKSA submitted a joint response to the Department for Work & Pensions November 2021 consultation “Enabling investment in productive finance – proposals to remove performance-based fees from the charge cap” where we made these points:
We would like to register our deep concern about the suggestions in this consultation paper.
We are seriously concerned that the DWP has failed to think these proposals through. The Ministerial Foreword says, for example, “In the last few months, the government, alongside industry and regulators, has made significant steps towards addressing the barriers to investment in long-term illiquid investments in the UK. We would prefer the DWP and the regulator to speak also to those who are likely to question the wider consequences for pension savers, such as UKSA and ShareSoc, and not just to those who have a vested interest in the approval of such fee structures.
This whole idea from the DWP sounds to us like something that has been put forward by members of the fund management industry and advisors to pension fund trustees to allow them to improve their own profitability.
We made 3 key points:
Firstly, fee structures in general are notoriously complex and usually disguised, nearly always confusing consumers to the extent that they are unable to assess whether the scheme offers value for money. Indeed, the suspicion often arises that the complexity of fee structures is designed to mislead consumers. Performance fees are even more complex.
Secondly, annual performance fees offer a free option to the manager. Even a strategy driven by dartboard will have some volatility which drives the performance positive or negative. If negative, the manager suffers no direct losses, if positive, the manager takes a fee, so the fee structure has option-like characteristics. We note with serious concern the suggestion that ‘clawback’, which would mitigate the optionality, could be banned.
Even if there is a hurdle, this will merely provide an incentive for the manager to leverage the exposure, leaving pensioners with even greater risk.
The proposed system seems weighted towards incentivising managers to take on greater risk – at no meaningful risk to the manager but at significant risk to investors.
Thirdly, there is no strong evidence that management of any kind can provide superior performance in the long run, as argued in a series of articles by Jonathan Ford in the Financial Times. Furthermore, the recent demise of the Woodford Equity and Income Fund, which has left many private individuals who were saving for their futures seriously out of pocket, is a salutary reminder of both the myth of the star fund manager and the dangers of putting investors’ savings into illiquid assets. This is particularly true when the investors (i.e. the members of a DC pension fund) may have little understanding of the assets in which their money is being invested and no idea of the risks.
 See e.g. “Private equity returns are not all they seem”, Financial Times, September 15 2019, arguing that ‘Public Market Equivalent’ figures are not so flattering for private equity. “A large study conducted in 2015 by three academics looked at nearly 800 US buyout funds between 1984 and 2014. They found that before 2006, these funds delivered an excess return of about 3 per cent per annum, net of fees, relative to the S&P 500 index. In subsequent years though, returns have been about the same as on the stock markets. A study of 300 European funds produced similar results.” https://www.ft.com/content/2812c2c6-d634-11e9-a0bd-ab8ec6435630 . See also https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3250315 which finds that funds with performance fees underperform those without.
The consultation paper can be read here https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1037175/enabling-investment-in-productive-finance.pdf
Our response can be downloaded here Enabling investment in productive finance 2022-01-17 FINAL
Cliff Weight, Policy and Campaigns Director, ShareSoc.