FCA examines barriers to investing in patient capital

The FCA's publication of a consultation and discussion paper comes after the chancellor’s 2018 Budget revealed measures designed to increase investment in patient capital or alternative investment assets such as infrastructure, real estate, private equity/debt, and venture capital with a view to delivering long-term returns.

Investing in real, tangible assets such as hospitals, toll roads and wind farms could provide an opportunity to show members where their pension money is actually being invested and how it is making a difference in society

Rona Train, Hymans Robertson

FCA looks to change rules

The FCA is exploring possible changes to its permitted links rules in its Conduct of Business sourcebook.

The aim is to address any barriers these rules may present to investment by retail investors in a wider range of long-term assets in unit-linked funds, while continuing to offer a suitable level of investor protection.

According to the FCA, the measures should “enable a broader range of long-term investment through unit-linked funds, particularly in defined contribution pension funds where members invest via unit-linked funds”.

The regulator is also looking to boost confidence and participation in the market by providing an appropriate level of protection for investors seeking to invest in illiquid or higher-risk patient capital assets within unit-linked funds.

Alongside the consultation, a discussion paper explores the impact of the regulatory regime on investment in patient capital through authorised funds.

Christopher Woolard, executive director of strategy and competition at the FCA, said: “We are proposing changes to allow retail investors greater access to long-term investment opportunities. We are also seeking views to help us identify any unnecessary barriers to investment in patient capital through authorised funds. We will ensure that any changes continue to provide an appropriate level of protection for consumers.”

Patient capital investment could boost engagement

A recent Hymans Robertson report showed that DC investment strategies lag behind defined benefit strategies.

Rona Train, partner and senior investment consultant at Hymans Robertson, sees the FCA’s proposals as positive, adding that “there is room for significant product development in this area”.

The government is looking at workplace pensions as a potential source of patient capital investment, as their long-term nature means they can consider longer-term and potentially less liquid investments.

“DC members are long-term investors so have the opportunity to benefit from the illiquidity premium that investing in patient capital can bring,” she said.

Another benefit could be increased engagement. Train highlighted that DC members are generally unengaged with pensions.

“Investing in real, tangible assets such as hospitals, toll roads and wind farms could provide an opportunity to show members where their pension money is actually being invested and how it is making a difference in society,” she noted. Train pointed out that it has been difficult for DC schemes to invest in patent capital for three reasons: the ability to price and deal daily, the cost, and the extra governance burden.

“While these arguments may hold when DC schemes are small, as we see schemes start to grow, and particularly master trusts gain significant scale, a number of these arguments largely fall away,” she noted.

While the challenge of daily pricing and dealing may remain “we must remember that we have had DC funds invested in property for many decades and clearly properties aren’t valued daily so it is possible to overcome the challenge”.

DC cost concerns

The government is to consult in 2019 on whether the charge cap for DC default funds should be changed to unlock greater investment in patient capital

Traditionally, investing in patient capital has been expensive, preventing many schemes from making allocations.

“However, if these investments are combined alongside low-cost passive equity assets, for example, schemes will be able to gain a more meaningful exposure. We also expect the costs of funds invested in asset types, such as infrastructure and private equity, to fall, over time, as more managers seek to appeal to the DC market,” Train said. In terms of governance, Train observed that many schemes currently use complex diversified fund strategies “so we see no reason why, with proper education, trustees and other fiduciaries should not be able to get themselves comfortable with using more alternative assets”.

Additional protections would be welcome

While there are potential benefits to investing in patient capital, some experts have expressed concerns over its suitability as an asset class.

Steven Cameron, pensions director at Aegon, warned: “Trustees will need to consider whether this type of investment has a place, particularly in default funds, where the majority of members auto-enrolled are invested without their active engagement.”

Train said additional protections afforded to higher-risk patient capital assets would be welcome, because it would encourage the use of pension assets to benefit the economy on a more social or ethical level.

“However, the FCA would need to be careful that the incentives or protections are not so prominent such that investors favour these over other assets and end up taking excessive risks,” she added.

Caroline Escott, the Pensions and Lifetime Savings Association's policy lead on investment and stewardship, said: “The uncertain economic and financial climate, combined with a low interest rate environment, has meant it is more important than ever that schemes have access to a wide range of investment opportunities and approach, to grow and protect the value of savers’ money.”

She added: “Pension schemes have told us that the current permitted links rules do act as a barrier to taking a patient capital approach and we look forward to working closely with members, and the Financial Conduct Authority, to help shape the final recommendations."