A new role for pensions and the City

Britain’s pension funds are undergoing an overhaul. A big chunk of this £3tn industry has caught the eye of the current chancellor, as it did the previous one, and has been found wanting. Too fragmented, too timid and too focused on charges to the detriment of all else. That’s a useful state of affairs for a chancellor looking for an enormous pot of money to help the government deliver on big growth promises. 

The core idea of creating pension mega funds for local government and auto-enrolment (ie multi-employer) schemes is sensible. The existing focus on value for money and caps on charges mean plans cannot consider more productive asset classes which offer higher net returns. Consolidation will bring scale, lower costs and a greater diversity of holdings.

Jeremy Hunt started the ball rolling when he asked pension funds to agree to invest 5 per cent of their assets in high-growth, innovative companies, the aim being to deliver higher returns for savers and to spark real economic growth. Rachel Reeves, however, is taking reform much further by hitching pension fund money to government-led infrastructure projects, as well as to its economic growth goals.

Reeves says “for too long pensions capital has not been used… to meet our infrastructure needs”. She wants to see pension schemes pump money into “vital transport, energy and housing projects”. The wording is worrying. While investing in infrastructure assets and private equity makes complete sense, should improve returns to investors, and can be justified by the billions received through tax relief, the government’s needs cannot become pensions’ chief priority.

Admittedly, Reeves’ is taking a leaf out of Australian and Canadian pension funds’ books. They invest far more in domestic infrastructure assets than their UK peers – funds down under invest around three times more in infrastructure than UK defined-contribution schemes and 10 times more in private equity (with a degree of cajoling by their respective governments to do so). There is no set target – yet – for the UK infrastructure goals, apart from some talk of unlocking £80bn. Disappointingly in this context, there is no plan to encourage pension funds to support UK equities, although there is a promise in the interim Pensions Investment Review report that this may be looked at again.

Some in the industry have expressed concerns. Matt Tickle at Barnett Waddingham says the “magnifying glass needs to shift from the sources of investment to the destination”. The UK’s planning and regulatory system, he says, continues to make infrastructure projects “inefficient and unappealing” to institutional investors. The Pensions Policy Institute echoes this, warning that the availability of high-quality domestic assets could be an issue. If schemes are required to invest in poorer quality assets, this could affect scheme funding levels with consequences for taxpayers. 

A second initiative from the chancellor’s office is the Financial Services Growth and Competitiveness Strategy. The wording here too is worrying. The government has rightly identified the financial services sector as a crucial driver of economic growth; rather more concerning is its intention “to design ambitious and targeted plans” for it, and state that once developed, its plan will serve as “the central guiding framework” for the sector. It has identified fintech (to reach parts of the economy not reached by traditional financial services) and sustainable finance (to transition to a net zero economy) as two of its priorities for the strategy. 

We will have to wait until spring next year to see what level of intervention the government is planning. At this stage, it certainly reads as though the government wishes to set the agenda.