By allowing pension fund trustees greater freedom and abolishing the minimum funding requirement, the Myners report could give the UK private equity market a much-needed boost, writes Hugh Arthur
At this year’s annual conference of the National Association of Pension Funds, a leading firm of accountants entertained guests with breakfast and a pensions-related quiz.
Question One went as follows: in his report to HM Treasury on ‘Institutional Investment in the UK’, did Paul Myners address the current incumbent of No 11 Downing Street as (A) Dear Chancellor, (B) Dear Mr Brown or (C) Dear Gordon?
The technically correct answer was (A). But our hosts considered that anyone who offered answer (C) deserved an extra ration of black pudding for emotional accuracy.
The Chancellor of the Exchequer had already made it clear that he was anxious to see institutional investors liberated from hidebound practices and perpetual navel-gazing.
The Myners report would therefore have made very appetising reading at HM Treasury’s offices in Parliament Street. The report was delivered on time, it was well written, and above all it criticised (albeit politely) not only the investment industry in which its author had made his own name and fortune, but also (even more politely) the clients who had been paying the fees for so many decades.
The report was also critical of the consultants in the middle, who make somewhat smaller fortunes from advising clients as to which investment manager currently deserves a turn at investing the clients’ money.
The broad recommendations from the Myners report are fairly well known – greater investment professionalism among the boards of pension fund trustees; the payment of trustees to become the rule rather than the exception; the abolition of any restrictions on pension fund investment which might be lurking in trust deeds and fund managers’ mandates; the unbundling of contracts for actuarial services from contracts for the provision of investment advice; the abolition of the minimum funding requirement (MFR), the much-maligned statutory solvency test for defined benefit pension schemes introduced on the back of the Maxwell reforms in the Pensions Act 1995; and, above all, the unscrambling of the institutional investment culture of ‘averageness’.
Fund managers, observed the report, were being judged (and paid) by their performance relative to that of other pension funds, rather than by their ability to achieve what was best for that particular investor with that particular liability profile.
Myners cites John Maynard Keynes’ likening of professional investment culture to the newspaper competition in which entrants have to choose the faces which correspond to the average preferences of prettiness shown by the competitors as a whole. As Keynes put it in relation to the investment field: “… we devote our intelligences to anticipating what average opinion expects the average opinion to be.”
Where does private equity come into all this? The clues are above. As long as the average pension fund eschews private equity as a significant part of its portfolio, so the next pension fund in line will follow suit.
As long as the MFR dictates (if not legislates for) a particular asset/liability match, private equity investment will not get much of a look in. And for as long as the average pension fund trustee does not understand how private equity works (or for as long as he only understands enough to lie awake at night worrying about ‘risk’), private equity is not going to feature very highly as an investment component in that fund’s portfolio.
Myners pays special attention to private equity and pension fund trustees. At first sight some of the statistics he produces make surprising reading – not for showing how little pension fund money is invested in private equity, but (given the ‘inhibitors’ mentioned above) how much is thus invested.
In 1999 some 8% of UK private equity investment came from UK pension funds.
My own firm’s experience over the last and busiest year we have had in private equity work puts a slightly different angle on the reliability of this figure.
“Of that total figure, I would estimate that well over one-half is attributable to the 20 largest UK pension funds,” says Bridget Barker, a funds partner here at Macfarlanes.
“Significantly, in terms of Myners, these are the funds where you tend to find the highest degree of investment professionalism, with much of the investment management being undertaken, or being closely monitored, in-house.”
It is when comparisons are made with overseas pension funds that the current UK figures pale into relative insignificance.
In 1999, nearly 30% of the total sources of investment in UK private equity came from overseas pension funds. Most of this money will have come from the US, where US pension funds alone account for more than 20% of all sources of venture capital. Again, much of this pension fund money will be concentrated within the largest funds (65 US funds have assets of more than $15bn (£10.7bn), compared with fewer than 15 funds in the UK).
The US private equity market is also much more mature than the UK market, with a correspondingly longer track record. And it is in this area of ‘track record’ that UK pension trustees feel most vulnerable to potential criticism.
The price of increased transparency in pension fund investment activity is an increased questioning of trustees’ decisions. That may in theory be entirely appropriate. It is after all the member’s pension, not the trustee’s pension, which is at stake.
However, Myners’ recommendation that pension fund members should automatically be given an even greater degree of information about funding targets, performance and actuarial projections is likely to be of questionable value. Charles Martin, a private equity partner here at Macfarlanes, summarises the position in the following way: “Successful private equity investment is partly about getting the right level of protection.
Too much is stifling, too little exposes the investor unnecessarily.”
For those who know what they are doing, the track record so far has been pretty impressive. I would certainly encourage any trustees who were considering putting their toes into the post-Myners waters to talk to the people who actually do the deals, in addition to the people who do the monitoring and who crunch the figures.
Subject to specific legal and regulatory restraints, there is no reason why trustees should not be actively engaged in monitoring the progress of their investments. To my mind, that would add to the interest of being a pension fund trustee in a much more cost-effective way than simply paying them to turn up at quarterly meetings.
In the meantime, we wait to see whether Myners’ two-year plan for voluntary adoption of his recommendations is sufficient to keep the Chancellor happy. One suspects that ‘Gordon’ may not be quite so patient.
Hugh Arthur is a pensions partner with Macfarlanes.
