When it comes to your pension, don’t believe the hype about private equity

Public speechifying can be intimidating, even for old hands. Before the event, some orators steady jangling nerves with a nip from a hip flask. Others spice up their notes with cherry-picked data.

I can only assume the latter applied when Torsten Bell, the pensions minister, extolled venture capital — investment in new start-ups — at a recent conference. The pensions minister wants more of our retirement savings to go into private assets.

Contesting “the idea” that venture capital returns are poor, Bell quoted the impressive 30.2 per cent payback achieved last year by the Ontario Teachers’ Pension Plan (OTPP).

He did not say how the C$280bn scheme fared with other private assets. So I looked the numbers up. Private equity made a -5.3 per cent loss. For real estate, the figure was -3.1 per cent. Despite a good performance in quoted shares, OTPP massively undershot its performance targets.

Bell also told delegates that the top quartile of UK venture funds outperformed the top quartile of every other private market asset class last year. So they did. But bottom quartile returns were lower than for some asset classes too.

I am being a bit mean to Bell. If cherry picking data to suit your opinions was a crime, financial columnists would be banged up in Wormwood Scrubs with the politicians. My reason for highlighting this example is that overclaiming is, in my view, a particular problem in the private assets industry.

This matters for us individual investors. If we leave our money in the default fund of a defined contribution pension scheme, some 10 per cent of it is liable to wind up in private assets, half of them in the UK. These targets are being pushed by a government whose enthusiasm for patriotic investment by private citizens reflects its own lack of capital.

If you manage your investments yourself, you may wonder whether private assets could lift your returns. Paybacks appear alluring, despite growing strains in parts of the industry.

My advice, as with all financial data, is to ask how reliable the numbers really are.

Last year, UK Private Capital, an industry body, reported a headline fund return of 12 per cent a year, after fees, from 2005 to 2024. That is massively better than the FTSE 100, which had a total return of about 6.3 per cent.

It is not a straight comparison, however. Total return numbers for a big stock market index rely on full datasets of verifiable prices and dividends. When private capital funds selectively report their progress, it is typically in the form of an “internal rate of return”.

“An IRR is not really a measure of performance,” says Richard Maitland, senior partner at wealth manager Sarasin. “It relies on too many suppositions and is often heavily reflective of results in the early years of investments.”

IRRs depend in part on subjective valuations that managers put on unrealised investments. Professional investors prefer benchmarks, such as “distributions [relative] to paid-in capital.” This measures cash paybacks over the life of an investment compared with outlay.

These figures are typically less impressive than IRRs and may understate returns. For example, UK Private Capital venture funds have reported a feeble median multiple of 0.21 times after fees since 2005. Large private equity funds have done better with a median figure of 1.36 times.

As with IRRs, submissions of distributions to paid-in capital data to UK Private Capital and other compilers are unaudited. The schoolchildren are marking their own homework, in other words.

The view of Sarasin, as an independent arbiter, is that private equity could return 10.4 per cent annually in years to come, against 7.4 per cent from global equities on a comparable basis.

It is questionable whether higher UK pensions investment in private equity would increase growth, as the government hopes. The core competence of buyout firms is to amplify equity returns from company ownership using hefty leverage. This works best at mature companies with improvable operating margins — hardly a starting point for a UK economic miracle.

Venture capital has more scope to stimulate innovation. But its hit rate in the UK has historically been poor.

Where does this leave the pensions investor? Here is how I would approach private capital:

Discount the wilder claims made by the industry and its supporters.
Assume returns have historically been higher, but riskier, than for blue-chip equities.
If your workplace pension contributions go into a default fund, check its underlying investments. If these include private assets you are uncomfortable with, exercise your right to choose something else.
If you decide to invest in private capital, thoroughly research this large and complex sector first. Recognise that much of it remains beyond the reach of small investors.
Only invest what you can afford to lose.

Independent peer and former pensions minister Baroness Ros Altmann told me in an email she fears pension funds “will be herded into high-risk illiquid assets”. This is a justifiable fear.

I have a concluding thought for Torsten Bell, given his interest in venture capital returns.

In the noughties, an earlier Labour government sank millions of taxpayers’ money into a range of venture capital funds intended to stimulate growth. A few years later, I asked government PRs how the funds were performing. They declined to share the data.

As a minister, Bell can presumably access those revealing numbers. If they are any good, he can quote them in a speech.

Jonathan Guthrie is a journalist, adviser and the author of ‘The Truth About Investing’. jonathanbuchananguthrie@gmail.com