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Article | Benefits Hot Topics

DWP plans to bring illiquid investments within cap

Pensions Corporate Consulting|Pension Board and Trustee Consulting|Retirement

March 22, 2021

The DWP has set out how it proposes to allow relevant DC pension schemes to calculate fees under the charge cap in relation to alternative assets.

The Department for Work and Pensions (DWP) has launched a consultation that seeks to bring additional flexibility to how the charge cap is calculated, thereby allowing default funds for relevant defined contribution (DC) schemes to invest in illiquid investments – such as infrastructure and start ups – with effect from October 2021.

The proposals are published as a standalone part of the Government’s response to the “Improving outcomes for members of defined contribution schemes” consultation, which included consolidation of smaller schemes among its objectives and on which the DWP hopes to publish final draft regulations and statutory guidance in June 2021.

This particular consultation focuses on ways of permitting investment in alternative asset classes, particularly venture capital and growth equity, within the charge cap of 0.75% – with Government having committed to keeping the cap at the current level in January. It now seeks to counter concerns that such illiquid investments are both too expensive and also inaccessible due to requirements for daily liquidity and pricing. The DWP plans to smooth the incurrence of performance fees over five years, which it believes would then allow trustees to invest in these vehicles to achieve the best possible return for their members.

The specialist active management involved in funds such as venture capital means that in addition to the fixed annual management fees, paid regardless of return, they also have a performance-related element. The most common type is ‘carried interest’, which crystallises at the end of the life of the fund. To work with this structure, the DWP has identified that it will also create an exemption from the requirement to include the performance fee when pro-rating fees for the charge cap calculation when members join or leave the scheme during the charges year.

While several respondents had identified that pro-rating will create more complex calculations as to whether members had remained within the charge cap, there was broad support for the five-year timespan and the Government has concluded that the “benefit of easier prorating … outweighs the cost of some increased complexity in administration”. And while continuing to confirm that this provides an opportunity to generate greater yield for members, the DWP is clear that it is for trustees to decide if they want to take advantage of the flexibility that this could bring, with the consultation containing some examples of how it could operate.

Finally, the DWP is also keen to obtain views on ‘look-through’, whereby trustees have to consider the cost of investing in the underlying assets when considering an open-ended or closed investment fund – but not those of a commercial entity that, for example, held a portfolio of properties. The Government wants to establish if the requirement for trustees to look-through deters them from investing in such funds.

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