Border to Coast: The problems with UK private equity

Private equity fees and a lack of high-quality, United Kingdom-focused fund managers targeting the scale-up sector is impeding UK pension funds’ ability to invest in private equity, according to a new report published by LGPS pool Border to Coast Pensions Partnership which has gathered views from its investment team, partner funds and senior executives at nearly a dozen leading asset managers.

The UK attracts a large slice of global private equity and venture flows into sectors like fintech, creative industries, life sciences and software, but very little of that money comes from domestic pension funds which are deterred by high fee structures that don’t accommodate defined contribution (DC) funds.

UK pension funds also have a statutory duty to cap fees which ignores the additional returns that investments with higher fees can deliver. Calling for clearer guidance from government and regulators, the paper argues pension schemes should assess value for money in their investments so that the focus isn’t just on management fees and value in isolation.

Government and regulators must lead the charge on highlighting the importance of considering net returns and the gains delivered after all costs, which in turn will ensure value for members both financially and in terms of broader economic benefit, says the paper.

“The Local Government Pension Scheme (LGPS) is already a significant investor in the UK, deploying a greater proportion of funds domestically than private defined contribution equivalents. But if government wants to unleash the full potential of the LGPS – and its £425 billion of assets – it should continue in its active engagement with the industry, and take note of the current blockers outlined in this report,” says Border to Coast CEO, Rachel Elwell.

Positively, large pension schemes, including the LGPS, are already significant investors in the UK.  Border to Coast, for example, has already invested more than £12 billion (23 per cent of total pooled investments) on behalf of its partner funds into UK public and private markets to date. This includes nearly £1.3 billion directly into UK private markets, making up 17 per cent of its partner fund’s pooled global private markets investment programme.

Since launching its private markets programme in 2019, Border to Coast has reduced the fees paid by its partner funds by 28 per cent relative to the industry standard. This success is down to the scale that pooling brings and the in-house team of investment experts that can build strong relationships with the right managers for the job. Expertise includes the design of bespoke investment vehicles with clear UK mandates like its UK Opportunities strategy, as well as access to co-investments offered by asset managers which were hard for partner funds to access individually.

Border to Coast aims to outperform a public market benchmark by 300 basis points and achieve annual net returns of 10 per cent from its private equity portfolio.

Limits to the UK asset management ecosystem

It’s not just fees that deter local private equity investment. Another challenge comes from the underdeveloped UK-focused asset management ecosystem. The report points to limited size, strength and number of domestic private equity managers – in particular those focused on earlier-stage companies in comments voiced by Border to Coast CIO Joe McDonell last year.

Fast-growing, young UK companies needing large-scale capital injections of over £20 million often struggle to find UK investors. Ensuring that more UK funds emerge to fill this expansion capital gap should be top of the agenda for the British Business Bank.

“Right now, UK pension schemes allocate so little to venture and growth equity that even the most in-demand UK-based managers are raising the bulk of their capital from overseas investors,” states the report.

It suggests that the government should also consider France’s Tibi scheme as a blueprint for channelling more capital into UK businesses. The scheme provides incentives for institutions that back innovative French technology companies and has significantly boosted France’s asset management ecosystem.

The report also highlights the need for reform in the UK’s planning system to encourage more infrastructure investment at home. Echoing other investors like IFM Investors, part-owned by DC-fund NEST, Border to Coast states that investment is being held back by the uncertainty created by the UK’s complex planning system and historical changes in government policy in areas like the green transition timeline. The report argues that these issues could be addressed by a more stable policy environment.

The authors call for a rapid passage of the Planning and Infrastructure Bill in a form that unblocks the UK’s planning system and the roll out of a well-designed ‘catalytic’ initiatives managed by the UK National Wealth Fund and GB Energy to develop infrastructure projects to the point where private sector capital can step in, de-risking greenfield projects and enabling the ’crowding in’ of private capital.

Amendments to the tax regime to incentivise wider infrastructure investment, akin to the Contracts for Difference regime for renewable energy infrastructure, would also support more investment.