The U.K. government's latest attempt to encourage defined contribution plan investment into alternative asset classes is missing a major issue: DC executives are unlikely to allocate to illiquids unless managers reduce their fees.
The government wants DC plans to help rebuild the U.K. economy in the aftermath of the coronavirus pandemic. It also wants to improve plan participants' retirement outcomes — something it has been consulting on with the industry over recent years. The problem is, plans must invest in a way that does not breach a 0.75% charge cap on default funds under management and administration — meaning pricier alternative assets are usually out of reach. Broadridge Financial Solutions Ltd. estimates that the proportion of U.K. DC assets allocated to private markets or illiquid investments, excluding real estate, is currently below 1%.
So in March, the government proposed that DC plans could spread the costs they incur from investing in private equity, venture capital and other alternative investments over five-year periods rather than looking at them on an annual basis — potentially allowing them to invest in more alternatives without breaching the charge cap. The new method would give plan executives the option of using a five-year average calculation for performance fees as an alternative to the in-year performance fees accrued, consultants said. Currently, plans can either look back at the year's data to determine charges or look at the planned charges to ensure they are compliant with the cap.
But despite the government's efforts, DC plan executives and consultants said an increase in alternative allocations by DC plans is unlikely until managers back down on 2-and-20 charging structures — where 2% refers to management fees and 20% to performance fees.
Sources also said that unpredictable returns of alternative asset classes will keep executives away from launching meaningful exposures without being "nervous" about breaching the cap regardless of fee spreading. And single-employer DC plans won't lock assets into a seven-to-10-year illiquid strategy if their sponsors have already decided to outsource retirement arrangements to multiemployer plans, known as master trusts.