Can Britain’s Pension ‘Megafunds’ Boost the Economy?

(Bloomberg) -- Low investment levels are one reason why the UK has endured more than a decade of subpar economic growth. So what could be more sensible than to divert more of the country’s pension savings into productive investments? 

The way the new Labour government is going about this is to pool £1.3 trillion ($1.6 trillion) of the UK workforce’s retirement savings into a series of “megafunds.” By creating fewer and larger funds, Chancellor Rachel Reeves hopes to release more private capital to support infrastructure projects and startups.

What the government isn’t doing, at least for now, is telling those pension funds where to invest their clients’ money. So a lot will depend on whether the new investment opportunities offer attractive returns. 

Why is the government overhauling pensions? 

The UK’s pension landscape is one of the most fragmented in the world, with over 8,000 pension funds spread across different categories: defined benefit schemes, which promise a fixed income; defined contribution plans, where payouts depend on investment returns and how much a worker and their employer chips in; and Local Government Pension Schemes for government workers. 

The country’s pension funds allocate just 4.4% of their assets to UK equities, down from more than half around the turn of the millennium, according to the New Financial think tank. The shift was triggered when the government introduced rules forcing retirement fund managers to be more open about their investments and how they planned to meet future pension obligations. This prompted them to shift more of their investments into safer government bonds. 

UK pension funds are also less invested in private equity and infrastructure assets than many of their peers in countries like Australia or Canada, where funds are more concentrated and have greater scale. 

What is Rachel Reeves proposing?

Reeves is planning legislation to merge the 86 local government pension plans in England and Wales, which are projected to have assets of £500 billion by 2030, into eight giant funds. The chancellor also plans to consolidate the £800 billion of assets held by about 60 so-called multi-employer defined contribution plans. 

What are the benefits of this consolidation?

The government estimates the changes could unlock around £80 billion for investment in infrastructure, startups and fast-growing businesses known as scaleups. 

Pooling of assets can reduce the fees and administrative expenses associated with managing smaller funds. Bigger funds are also better positioned to attract portfolio managers with the expertise to oversee more complex investments. 

An earlier consolidation of local government pension plans launched in 2015 achieved annual savings of £180 million, according to the government. The enlarged entities significantly increased investments in private market assets, with UK and global infrastructure assets growing to around £27 billion from less than £1 billion. 

Will this boost investment in the UK?

The National Infrastructure Commission says the UK needs to increase private sector investment to between £40 billion and £50 billion in the 2030s and 2040s from £30-40 billion over the last decade in order to “rebalance its economic geography, meet climate obligations, improve resilience and enhance the natural environment.” 

So if the government were to achieve only a fraction of the potential £80 billion in additional investments, it could make a difference to the country’s economic performance. 

However, it isn’t mandating pension funds to invest in UK assets, and whether pension funds end up channeling more into domestic investments will depend ultimately on how attractive they are. Policy initiatives including a government industrial strategy and planning reform will be critical for ensuring a pipeline of investable assets, according to The Pensions and Lifetime Savings Association. 

Which sectors could see more investment? 

The PLSA put together a list of sectors that need investments and could attract more pension fund cash: 

Will the government end up forcing funds to invest more in the UK? 

Pensions Minister Emma Reynolds told the Financial Times that if the new megafunds don’t increase British investments, they could be mandated to do so. Such a move would face stiff resistance from pension funds, whose fiduciary duties require them to act in the best interests of their customers. 

The government may adopt other methods to avoid triggering a revolt by the pensions industry and a clash with regulators. One option would be to claw back pension tax breaks from asset managers who fail to invest enough domestically. Australia does something along those lines, offering tax advantages to domestic pension funds for investing in local stocks. 

Are other pension reforms in the pipeline? 

The industry expects the government’s next target could be the defined benefit pension plans serving some of the largest UK employers. These have at least £300 billion in assets over and above what they’re committed to paying out to retirees, and this could grow to £1 trillion over the next 10 years, said Van Lanschot Kempen. The wealth manager said a large proportion of that could be used for investing in productive national assets without any risk to pensioners. 

Pension experts say the government may also increase the minimum pension plan contributions required of employers and employees. Increasing this from the current 8% of an employee’s annual salary to 12% could bring an extra £10 billion into the industry every year, according to estimates by pensions provider Phoenix Group Holdings Plc. Bigger pension pots would mean more investments, even if the proportion invested in the UK remained unchanged.  

©2024 Bloomberg L.P.