Defined contribution (DC) members in the default could see a 7% to 12% increase in total retirement savings by having investments in venture capital and growth equity, research shows.
According to a report on the future of DC - published today by the British Business Bank (BBB) and global management consultancy Oliver Wyman - this could be achieved by allocating an average 5% to venture capital and growth equity over a members' working life from the age of 22.
Venture capital and growth equity are both forms of private equity investments - the first looking to invest in early stage businesses and the second looking to provide private capital to more mature businesses which are looking to grow further.
Based on long-range historic performance from 1970 to 2016, these assets have delivered an average return net of fees seven percentage points a year higher than that seen in public equity markets, the analysis found.
To come to its conclusions, BBB and Oliver Wyman examined the relative performance of venture capital and growth equity investments against a benchmark for listed equities.
The pair analysed the performance of over 5,000 funds globally and completed interviews with experts from more than 50 organisations across the pensions and venture capital and growth equity industries, as well as regulators and those in government, over nine months.
The research showed that global venture capital and growth equity had outperformed stock markets on average over a sustained period. For example, since 1970 the asset class had delivered an average 18% net return per year compared to 11% for the MSCI World Equity Index, the report said.
While the report noted investing in illiquid assets will always create some liquidity risk, it is intended that these private equity investments would only make up a small share - around 5% - of the overall portfolio of a DC default fund.
The 0.75% charge cap and daily dealing requirements on many DC platforms makes it difficult for schemes to invest in illiquid assets, and rarely feature in default strategies. Nonetheless, the government wants to extent the way compliance with the AE charge cap to make it easier for trustees to invest in illiquid assets.
BPC chief executive Catherine Lewis La Torre told PP lots of pension plans have "shied away" from some alternative assets like venture capital because they believe the performance just isn't there.
She said: "The research shows very clearly this is not true and there is good performance. But what you do have in venture capital is a wide range of outcomes, depending on the manager in the vintage that you're investing in so manager selection is really, really critical in this in this area.
She added: "You need to be selecting the top quartile fund managers that are able to execute these strategies more successfully than others."
However, Lewis La Torre recognised that there are areas where more work needs to be done to make investing in venture capital and growth possible such as: more information, education around what this asset class is and what's achievable, and the regulatory piece, which is a "key piece of the challenge".
She said: "This is a challenge the industry has to solve but we can be helpful in providing information and education. We'd like to focus in on the UK and Europe to demonstrate what's achievable for DC plans electing to support VC funds and companies more broadly."
Oliver Wyman partner John Whitworth said he thought a large number of trustees would show interest in this type of asset class.
He said: "An education process on this is a starting point. We're not saying interest will emerge overnight, but the economic case has been made and the industry infrastructure around providing support to trustees in decision making will follow."
The study builds on the Treasury's Patient Capital Review in late-2017, which considered how to increase the supply of capital to growing innovative firms.
Commenting on the BBB and Oliver Wyman research, exchequer secretary to the Treasury Simon Clarke said: "Pensions savers across the UK deserve financial security in retirement, and this review is a helpful contribution to that.
"We are keen to support pension funds to invest in the UK's fastest-growing and most-innovative companies, so that savers can benefit from their success, while at the same time boosting the economy."
This research comes a week after The Pensions Policy Institute's DC Future Book 2019 found members could see an increase in their pension pots of between 2-3% if they were invested in a default fund that had a 10% to 15% allocation to illiquid assets such as infrastructure or real estate.
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