Which UK SMEs will benefit from DC pension investment in patient capital?
7 December 2018
It should be win-win all round. Plans announced in the Autumn Budget to explore making it easier for Defined Contribution (‘DC’) pension schemes to invest in innovative, high growth SMEs, mean ambitious UK businesses may get access to a vast pool of capital . Pension schemes meanwhile could enhance portfolio diversification with a sensible allocation to such investments - called ‘patient capital’ to denote their longer-term nature.
However, my concerns are that not all investors and businesses will necessarily benefit, and a substantial part of the market could remain cut off. And beyond that, why is facilitating access to other important types of long-term alternative assets being overlooked?
Innovation, innovation, innovation
The document setting out the proposals is entitled ‘Financing growth in innovative firms’, which in practice, is typically going to mean that the emphasis is on supporting early stage (and particularly tech) companies with venture capital, rather than larger, more established SMEs with the potential and desire to grow.
There are three key reasons for this.
Firstly, the Government has already signalled where its priorities lie. The shifting of tax breaks designed to stimulate investment in SMEs under the Enterprise Investment Scheme (EIS) onto young companies, has left those older than seven years old, for the most part, high and dry.
I believe the same attitude is at play here. The idea is to give innovative new companies, that could be the next Google or Amazon, the backing they need, and enable pension schemes to get in on the action.
All well and good. But the risk, is that less ‘innovative’ or exciting businesses – ones that have been around longer or aren’t in cutting-edge sectors but are nonetheless ambitious engines of growth, significant job creators and contributors of tax receipts - will get passed by.
Secondly, larger pension schemes that already have allocations to private equity may see venture capital, rather than later-stage SMEs, as the more natural foil to their existing investments, which are likely to be at the large-to-mid sized end of the private equity scale.
Lastly, venture capital funds are relatively plentiful, whereas funds that target investments in more established small businesses are not, making them harder to access.
Yes, venture capital can be very rewarding when stellar investments take off, but it is at the riskiest end of the market, and there needs to be a balance here. My view is that there should be a greater drive towards a mixed focus, with a wider remit than simply backing innovation and there should be an element of later-stage growth SMEs alongside venture capital.
Pooling capital: who benefits?
The next question is: how can this shift towards greater institutional patient capital investment be achieved? The policy document makes clear that regulatory barriers are one factor that needs to be addressed; the fees and difficulties of investing in these kinds of assets are another.
To get around the latter, pooling capital to create a ‘new joint vehicle for patient capital’ has been mooted, with several big-name pension players committing to explore options of how this collaborative approach might work.
It’s a laudable aim, but it’s hard to see how it benefits the bigger schemes, who are quite capable of managing their allocations themselves.
Will they really take the lead to benefit smaller schemes who struggle to access this segment of market in a sufficiently diverse and efficient manner, or at all, given that funds of funds (the most obvious solution) tend to have narrowly-focussed strategies and charge fees on top of fees?
And if the aim is to bring costs down by working together and creating economies of scale, how successful will that be? There is a huge amount of expertise and skill involved in the venture capital and growth capital space – you simply can’t do it cut price.
The solution already exists
While policy-makers and industry players ponder that conundrum, which may well take some time, we’ve already found the solution. We have a well-established track record pooling capital – from smaller institutional investors, family offices and private investors – often alongside larger institutional investors, in such a way that makes such investments accessible.
And by that, I mean offering a range of high quality opportunities that are subject to professional, expert due diligence and oversight, all with lower entry minimums to facilitate portfolio diversification.
My final point goes broader.
As well as promoting investment in early-stage private equity, why aren’t policy-makers also focussing on making it easier for pensions schemes to include other illiquid alternative asset funds, such as specialist credit funds or niche strategies like commercial litigation funding?
These are likely to have a lower risk profile than venture capital, while still providing the potential for impressive returns and providing much-needed funding lines that ultimately benefit UK plc too. All key reasons why they are part of our offering as well, made accessible in much the same way as we do with private equity.
A diverse approach
In today’s turbulent, heated, public market conditions, it’s sensible for investors to be holding a portion of illiquid assets to counterbalance volatility and seek true portfolio diversification. But the focus should not be solely on venture capital. The smaller end of the private equity market has something different to offer and later-stage SMEs should be on the menu too.
Nor is funding innovation the only route to success – solid businesses in less exciting sectors need backing as well and can be very rewarding. And if we’re looking into the benefits of being ‘patient’ with your capital, surely other long-term alternative assets should be part of the mix too.
There’s clearly a lot to chew on here, and while policy-makers are doing that, we’re here for any SMEs or smaller pension schemes that want in and can’t wait.
Claire Madden, Managing Partner. Dec 2018