The writer is chief executive of Business Growth Fund
It has been almost 100 years since economists including John Maynard Keynes identified the “Macmillan gap”. The term tracks the funding shortfall that starves small- and medium-sized British companies of the finance they need to grow. The gap can widen to a chasm in times of crisis, such as today. But there is, I believe, a way to close it and prevent deep economic scarring across the UK, by unlocking the firepower of British pension funds.
Across the economy, just about all of the short-term measures that can release cash to companies have already been used. Most of them are based on credit — from the government’s Coronavirus Business Interruption Loan Scheme to companies adjusting their balance sheets or deferring liabilities. But debt is never a sustainable solution. The UK needs to find longer-term solutions to fuel economic recovery, or risk disaster.
The most acute funding challenges concern “growth economy companies”. There are around 21,000 of these in the UK, according to research for the Business Growth Fund, the investment company set up by British banks after the 2008 financial crisis, which I run. They make up the dynamic midsection of our private sector. Highly profitable and fast-growing — on average increasing revenues at twice the pace of economic growth — they are our future. However, they are generally too small to be funded by public markets, while often having outgrown venture capital.
The solution to this problem is the creation of a UK National Renewal Fund, with £15bn of equity capital, to channel patient capital to these companies. This pool of capital will be made up of equity investment from the pensions industry, insurance companies, quoted investment trusts, sovereign wealth funds, private clients and, as an extension of the government’s Future Fund, state funding where appropriate. Funds will be deployed locally and on a commercial basis. They will help to level the country up, not down.
The pension fund component would be transformative, by unlocking vast pools of capital. Generally speaking, trustees of defined benefit schemes already have enough flexibility to invest growth funds in growth companies. But over time this funding will diminish as such DB schemes run off. In contrast, regulatory change is needed to allow the fast-growing defined contribution schemes to make such investments at scale.
I believe this could be game-changing, given that a growing proportion of UK pension assets are held in such DC schemes. The opportunity is to unfetter trustees and allow them to follow broader investment strategies that can deliver higher returns and support the growth economy. It would join a nation of savers to a small army of entrepreneurs and innovators.
It is clear that this type of investment could benefit scheme members too. According to the British Business Bank, the UK state development bank for SMEs, a 22 year-old could increase the value of his or her final retirement pot by between 7 and 12 per cent if they invested 5 per cent of their pension in venture capital and growth equity. But smart regulatory thinking is required so that pension trustees can invest in growth capital on their behalf. Here is how that could be done.
At the moment, trustees generally require support from investment managers to create the portfolios they want. That means they must also pay the managers for their expertise and time. But there is a hurdle: the so-called charge cap. This imposes a limit of 75 basis points to the total fees charged to any individual in a DC scheme’s default fund. As such, it also limits what trustees can spend on investment and administration. This makes it almost impossible for them to invest in venture capital or growth equity, despite the higher absolute returns this should generate.
To address this, the government should exclude performance fees from the charge cap for relevant growth equity and venture capital investments, and let trustees make decisions based on absolute returns. Such carve-outs could be certified by the BBB — as it does for the growth equity funds it backs. Until this happens, trustees will remain discouraged from making such investments.
Unlocking the firepower of UK pension funds could provide fast-growing smaller businesses with the financing they need to grow, employ and invest. It is obvious that we cannot sit idle and hope for the best in the long term. Instead, the government and British financial institutions must be bold. For nearly a century, the Macmillan gap has been a major flaw in the UK financial system. We now have an opportunity to close it and get on the road to recovery and a brighter future.