Pensions are not usually considered the sexiest of discussion topics. But suddenly MPs from both of Britain’s main parties are falling over themselves to talk about them. The penny has finally dropped on how the country’s vast pension savings of about £3tn — one of the largest globally — could be deployed more productively to boost the UK’s long-term economic growth prospects. The bulk of total pension assets are stashed in low-risk, low-yield bonds. Unlocking just a portion of that for long-term investment in promising British businesses and infrastructure projects would drive higher productivity.
The consensus on finding ways to sweat Britain’s pensions assets harder is welcome. The average allocation to UK equities by UK defined benefit pension schemes — which provide retirees a specified income — has fallen from close to 50 per cent in 2000 to below 2 per cent today. This has sapped the London Stock Exchange. But since reversing this trend involves shifting the savings of millions of individuals into riskier and less liquid assets, albeit probably with higher returns, how it is achieved is important.
The Conservative government has not ruled out mandating funds to invest more in the UK — something the opposition Labour party recently suggested it could support. Compulsion is not the right approach. Investment decisions need to be made in the best interests of savers, and effective risk management requires freedom from other constraints. The ability to invest in global assets also provides important channels for diversification. Instead, policymakers should focus on raising the low incentives pensions funds face in investing in UK assets in the first place.
Defined benefit funds have historically been the dominant pension type. Accounting changes in 2000 that forced companies to recognise deficits or surpluses on their balance sheets encouraged the shift into longer duration, and less risky, fixed-income assets. With the funds more than £300bn in surplus, rules could be reviewed to help stimulate investment in other asset classes. Supporting the consolidation of Britain’s 5,000-plus DB schemes could also create a better buffer for riskier investments.
With fewer DB schemes open to new members or seeking returns, defined contribution schemes — which provide retirement incomes based on individuals’ investments — may be a better vehicle. They are projected to surpass £1tn in holdings by 2030, and already allocate the majority of assets to equities as they are not obliged to provide fixed returns. Again, pooling the plethora of small DC schemes could incentivise chunkier investments into alternative assets. Reforming the pensions charge cap, which is designed to protect savers from excessive fees, could also unlock greater access to managers investing in less liquid assets, such as unlisted equities and infrastructure.
The skills and knowledge of pension professionals will also need improving. Investing in riskier and more opaque asset classes such as private companies and road and rail projects requires specialist due diligence. Regulatory resources to monitor dicier investments will also need scaling up to ensure retirement savings are protected.
Ultimately, the biggest check on pension funds investing in UK plc will be confidence in the economy. Political instability and the absence of an industrial strategy have encouraged myopic and risk-averse investing. A poor record of delivering fruitful public investments on time does not help. Even if UK pension funds are set free from regulatory burdens and armed with more sophisticated investors, without more capable and clear-sighted political leadership there is no guarantee they will invest in promising companies or infrastructure projects in Britain.
