(Bloomberg) -- The practice of de-risking defined contribution pension pots as savers close in on retirement will cost the UK as much as £25 billion ($32 billion) during the current Parliament, according to asset manager Columbia Threadneedle.
Cautious investment strategies are undermining government efforts to drive funding into UK listed companies, startups and infrastructure, Columbia’s head of dynamic real return Christopher Mahon said. The arrangement, — known in the industry as “lifestyling” — is a hangover from before “pension freedoms” reforms in 2015 and is “costing savers and the country excessively,” he said.
In November, Chancellor of the Exchequer Rachel Reeves pledged “to power growth in our economy” by consolidating smaller defined contribution plans into Canadian and Australian-style “megafunds.” A culture of risk-aversion in the UK investment industry has gone too far, she added.
Reeves wants smaller schemes to merge into £25 billion funds to cut fees, spread risk and enable them to deploy larger amounts of capital into major UK projects, which would help the economy and improve returns for members. Savers are losing £12,000 on the average-sized £107,000 pension pot over five years due to “lifestying” risk-aversion, Mahon said.
Last month’s interim Pensions Investment Review noted that Britain’s “£3 trillion pensions industry has the third-largest stock of assets in the world” but said “the government is concerned that UK pension funds are investing significantly less in the domestic economy than overseas counterparts.” London, which was once a premier venue for public listings, has fallen to 20th place in a ranking of global IPO venues as domestic pension funds shun the UK.
In a sign of government frustration, Reeves has refused to rule out forcing funds to invest a fixed proportion of assets in the UK. Louis Taylor, chief executive of the state-owned British Business Bank, said one idea was to make funds repay pensions tax relief if they fell short of a UK asset allocation threshold. Pension tax relief is worth around £50 billion a year.
Mahon welcomed Reeves’ consolidation plans, but said a simpler “lifestyling” change could be more effective. In Australia, where returns and domestic investment are significantly higher than in Britain, two-thirds of plans avoid “lifestyling,” according to data from the Australian Prudential Regulation Authority and Pension Policy Institute.
Tacit Endorsement
Under lifestyling, pensions are gradually de-risked over the five to 10 years before retirement, with equity allocations reduced on average from 75% to 25% in favor of bonds and cash, according to Mahon’s analysis. De-risking worked when people were required to buy an annuity on retirement, but the rule was scrapped in 2015. Even so, “nearly all defined contribution schemes use the approach” and regulators “tacitly endorse” it, Mahon said.
Older savers typically have 4% of assets in the UK stock market compared with 9% for younger savers, Mahon calculated from official data. The Pension Policy Institute has estimated that defined contribution plan assets will grow to £1.3 trillion by 2030, two-fifths of which are held by older savers.
Maintaining the 9% asset allocation in UK companies for older savers would release £25 billion for productive investment by 2030, Mahon said. His analysis showed that “size makes little difference” to returns for schemes above about £10 billion. “Cutting costs is a help, but no cure for this regulation-driven risk aversion,” he said.
Callum Stewart, head of investment proposition development at Standard Life, said has become more sophisticated in approach than it was in the past.
“The reality today is very different,” Stewart said. “The de-risking approach adopted in modern lifestyling is designed to achieve growth and manage risk through diversification.”
Australia wasn’t a fair comparison, he added, because bigger employee pension contributions and a “longer-term focus” combine to provide “greater potential for Australian superannuation funds to invest in growth markets for longer.”
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