Pension funds have traditionally been quite conservative in their investments, but there are growing calls for reform of the way these vast pools of money are managed, potentially mandating investments in UK companies, infrastructure and sectors such as technology.
The Tony Blair Institute for Global Change, a think tank, recently proposed the creation of pension superfunds that “invest in Britain’s economic future”. Meanwhile, Labor has backed a proposed £50billion “future growth fund” and said they could potentially force pension funds to invest in fast-growing UK companies.
The idea is to use pension funds to boost the UK economy, particularly in areas like AI and life sciences.
However, the pension industry has hit back at some of these proposals, particularly where there is talk of forced investment in certain assets.
As Joe Dabrowski, associate director for policy for the Pensions and Lifetime Savings Association (PLSA), puts it: “We do not believe that mandating investments in certain asset classes is a sensible practice. The systems are not homogeneous and it is the responsibility of the trustees to ensure that their investment approach suits the needs of the members. With defined benefit (DB) schemes, it is also important to consider the impact on the employer who pays the costs.”
Fixed Income Super Funds and Consolidation
The Tony Blair Institute is proposing to expand the Pension Protection Fund (PPF) into the country’s first “superfund”. Small DB schemes could elect to transfer into the fund and over time a “set of regional not-for-profit bodies” would take over the remaining DB funds, the UK’s 27,000 defined contribution (DC) funds and possibly public sector pension schemes.
She claims the changes will ensure better returns for retirees and boost investment in innovation, the energy transition and in London as a global financial hub.
The UK has chronically underinvested in our own infrastructure and ideas. We need to invest in ourselves again
To encourage consolidation of DB funds, the institute recommends the use of tax incentives – which would be conditional on a minimum investment in UK companies and qualifying infrastructure assets, say 25% of assets.
Other ideas include a £50bn fund investing 5% of all DC schemes – proposed by Lord Mayor of the City of London Nicholas Lyons and backed by Labor – and the government’s Long-Term Investments in Technology and Science (Lifts) initiative, which aims to change the risk-return component of an investment and make it more attractive to DC pensioners.
The government recently said pension funds need to adopt a culture of risk-taking, and Chancellor Jeremy Hunt appears to be considering the PPF Superfund proposals.
According to a government spokesman, the goal is to “increase the growth potential of pension funds – making it easier for them to invest in a broader range of high-growth companies to increase returns for savers and spur economic growth.”
Do Bigger Fixed Income Superfunds Lead to Higher Returns?
Jeegar Kakkad, policy director at the Tony Blair Institute and one of the report’s authors, argues that the UK has the third largest bond market in the world but does not have one of the top 40 global superfunds, and “it has hurt pensioners and the economy”.
He says a key benefit is size. “A larger fund can make better asset allocations and should benefit from the relatively higher, longer-term returns that come from investing in assets such as infrastructure in the UK.”
The report highlights the dramatic drop in pension funds invested in UK equities and the corresponding increase in bond investments. At the beginning of 2000, more than half of pension assets were invested in UK listed equities, while only 15% was held in bonds. Today the numbers are 4% and 60% respectively. Kakkad states: “The UK has chronically underinvested in our own infrastructure and ideas. We need to invest in ourselves again and the Superfund frees up the capital to do that.”
Becky O’Connor, director of public affairs at pension provider PensionBee, agrees that merging pension funds brings economies of scale and eliminates the administrative costs of running smaller schemes. And she recognizes that the potential benefit of higher risk is higher growth, which could translate into higher pensions for all of us.
The downside, however, is that the companies that receive the money are not successful and generate no returns for retirement savers. “It’s a pretty big risk,” she notes.
The reality of riskier retirement investments
Investments in immature infrastructure or high-growth companies can be particularly risky. According to Dabrowski, “certain high-risk asset classes are only appropriate for pension schemes under the right circumstances and with the right products as part of a balanced portfolio.”
He adds that there is a risk of creating asset bubbles if the systems have to invest in the same products.
Meanwhile, mandating a certain percentage of UK investments could also be seen as risky, given the track record of the FTSE 100 and the possibility of missing out on strong performance elsewhere. Over the past decade, the FTSE has returned 2.9% on average each year, while the MSCI World Index has returned 9.17%.
There’s also the argument that DB pensions are better suited to “safe” assets such as long-term debt. Expiring schemes need assurance that they can pay member benefits without requiring additional employer contributions. The DB sector therefore invests heavily in UK government bonds (which own 80% of this market) and provides the government with a willing buyer and long-term capital to invest.
Jos Vermeulen, Head of Solution Design at Insight Investment, comments that a potential impact of diverting money from UK government debt to other assets “is likely to increase funding costs for the government, which may need to be covered by higher taxes”.
One of the main reasons for reluctance to make mandatory investments – and reluctance to make large-scale changes – is that the pension money belongs to the savers. If an investment fails, savers could suffer. The pension industry argues that its priority should be providing members with good retirement outcomes, not boosting our economy.
However, there could be other ways to encourage pension schemes to invest in the UK, such as tax incentives for domestic investment, similar to those in France and Australia. And Dabrowski points out that pension schemes manage trillions of assets, so with the right products, a small investment by individual schemes in UK assets can make a big difference.
