The DWP has launched a consultation on proposals to remove “well-designed performance fees” from the charge cap which applies to the default funds of occupational defined contribution schemes used for automatic enrolment. Its aim is to make it easier for such schemes to invest in asset classes such as green infrastructure, private equity and venture capital.
At present, regulations make a number of exemptions from the charge cap, for instance transaction costs. The DWP is proposing to add “well-designed performance fees that are paid when an asset manager exceeds pre-determined performance targets” to the list of exemptions. This would replace recent regulations which keep performance fees within the cap but allow them to be smoothed over five years (though DWP is keen to understand whether this would disrupt any ongoing fee negotiations). Details that the Government is consulting on include whether to confine the exemption to certain asset classes and whether to incorporate specific hurdle rates into the regulatory definition of performance fees.
A traditional “2 and 20” fee structure sees investors pay a flat 2% of the value of assets under management in a fund, plus 20% of any returns above a specified threshold. If the DWP’s proposals are implemented, the 2% charge, which is unrelated to performance, would still count towards the 0.75% charge cap for the portfolio as a whole, but the 20% performance fee could be ignored. This means that the remaining investments in the portfolio would need to have charges below 0.75% for the scheme to comply with the charge cap. DWP hopes this will encourage trustees to explore fees based on performance and encourage managers to design fee structures that schemes can pay: a lower flat fee combined with a higher performance fee will be easier to accommodate within the charge cap where that latter element can be excluded.
Assuming a favourable response to the consultation, DWP plans to publish draft regulations early in 2022 with the final versions taking effect in October 2022. It envisages that if performance fees are excluded from the cap they would need to be disclosed to members through the Chair’s statement. The consultation also holds out the prospect of “several initiatives” intended to shift DC schemes’ investment focus from cost to value, though the timing and content of such initiatives are not disclosed.
