Nest seeks lower PE fees in return for regular capital allocations

Nest is searching for private equity managers that are prepared to cut fees in return for a regular capital stream from the UK’s largest workplace pension scheme.

Nest, which manages more than £16bn of retirement savings, is expanding its portfolio of illiquid investments, including green energy infrastructure and commercial property, but it has yet to make a commitment to private equity due to concerns about high fees.

“We won’t pay two and 20,” said Mark Fawcett, chief investment officer at Nest, referring to private equity’s usual two per cent management fee and 20 per cent performance fee.

Nest is gathering about £5bn a year in contributions from its 10m members and it is expected to have around £100bn in assets under management by 2039 as more younger workers are auto-enrolled into its pension savings scheme.

It intends to allocate 5 per cent of its assets to private equity, which would provide a stable capital stream for any private equity group that meets its criteria. It wants to establish open-ended evergreen funds with private equity groups that will acquire growth companies.

“We think this is a new bargain that can deliver better results for both pension savers and private equity managers,” said Fawcett.

The UK government wants to encourage defined contribution pension schemes to increase allocations to private equity and venture capital investments as part of prime minister Boris Johnson’s plans to “build back better” after the coronavirus pandemic.

The Department for Work and Pensions is consulting on whether to relax the 0.75 per cent annual charge cap that applies to DC pension schemes to enable them to pay performance fees for illiquid investments.

Averaging performance fees over a rolling five year period would allow such schemes to exceed the annual 0.75 per cent charge cap in some years without being penalised. But this might not solve the issue of performance fees for private equity, which tend to be lumpy and concentrated in the years when portfolio company investments are harvested.

Most DC schemes will find private market strategies to be too expensive even if performance fees were smoothed over a number of years, according to Nest.

“The total level of fees levied by most private market funds will remain too high for many DC pension schemes to access,” said Fawcett.

Due to strong investor demand, private equity managers have proved almost immune to the downward pressure on fees that is affecting most of the investment industry.

Private equity managers raised $989bn in new capital last year, down from 2019’s record $1.09tn, according to Bain, the consultancy.

Growing numbers of large institutional investors have increased their use of co-investments alongside private equity managers. This can reduce fees but it alters the risks faced by the investor.

Nest will assess co-investments at a later stage and could eventually build an in-house private equity team, the model championed by some of the largest Canadian pension plans.

Nest will also insist that high environmental, social and governance standards are integrated into its private equity strategies. “We won’t compromise on ESG. This is an area where private equity needs to raise its game,” said Fawcett.