The Patient Capital Review is the Government’s attempt to encourage more investment into long-term illiquid assets such as venture capital, private equity and infrastructure projects by private and institutional investors.
In a more logical world, this would seem like an easy match to make. After all, research has shown time and again that illiquid assets tend to outperform liquid asset classes over the long-term.
We are also constantly being told that young people need to save more and for longer to provide adequately for their retirement. Which is not an inviting prospect at a time when average student debt is rising to in excess of £50,000, only to be followed by the challenges of saving for a deposit for a house which, for many, will take them well into their thirties before they can even start to think seriously about retirement provision.
If saving more and saving longer is problematic, the answer should be to make sure that every penny that an individual commits to a pension delivers the best possible long-term returns. So we should, in theory, be seeing a rise in the level of assets being committed to ‘riskier’ long-term and illiquid asset classes.
In fact, nothing could be further from the truth. Instead we are seeing the rise of model portfolios, balanced mandates, and passive portfolios all committed to mainstream equity and bond markets.
You can’t blame the investor for this. If you are looking at a pension plan’s default strategy saying it is suitable for someone looking for ‘capital growth at lower risk’, what’s not to like? Except for the fact that, for anyone in their twenties, this should probably be followed by ‘and are happy to wait a decade or two more than you need to for a decent income in retirement’.
So how do we correct this bizarre situation where investors are shunning the very investments that could help them achieve their investment goals in a realistic time-frame?
The Patient Capital Review has helpfully acknowledged the role that investment companies could play in this. After all, the asset classes that make up ‘patient capital’ are not the type that retail investors can access directly. Wrapping them into the listed fund structure provides liquidity, transparency and independent governance. In fact, you could say that investment companies embody patient capital, as they are not prone to the short-term inflows and outflows which can be so difficult for investors in open-ended funds investing in illiquid assets, as investors in open-ended property funds discovered after last year’s Brexit vote.
The AIC’s members have already shown how investment into patient capital can be successfully done, with Venture Capital Trusts delivering attractive yields and capital growth from investment in small, growing businesses for more than two decades, and the infrastructure sector booming to become the 4th largest AIC sector in little more than 10 years.
But this will still not solve the broader demand issue. It looks like the Government is not minded to use tax incentives to boost demand, so the Patient Capital ISA recommended by the AIC and Neil Woodford will have to wait another day.
So perhaps the answer is to look again at how investors are marketed to and advised when saving for the very long-term such as pensions. To help them to understand that, however comfortable they may feel about downside protection, the reality is that this is likely to cost them in the long run. A sudden stock market crash is immediate, painful but, in time, recovers. The problems caused by an inappropriately low risk investment strategy accrue slowly, are less visible but, in practice, can be far more damaging and lasting.
We sometimes talk blithely about ‘risk’ but, for many investors today, it is this structural risk aversion, aided and abetted by parts of the financial services sector, that is the real risk.
Ian Sayers is chief executive of the Association of Investment Companies