In her first speech as Chancellor of the Exchequer, Rachel Reeves was emphatic that private capital would be essential in driving the new Labour government’s growth ambitions. Reeves was also clear that the nation’s retirement plans will be firmly in the government’s crosshairs as target investors in domestic projects to achieve that growth.
Speaking four days after July’s general election, Reeves said: “We will turn our attention to the pensions system, to drive investment in homegrown businesses and deliver greater returns to pension savers.”
Then in August, the government announced the Pensions Investment Review with the aim to “boost investment, increase saver returns and tackle waste in the pensions system”.
The first phase of the review will focus on investment and report initial findings later this year ahead of the introduction of the Pension Schemes Bill.
The second phase will start later this year and alongside investment, will consider further steps to improve pension outcomes, including assessing retirement adequacy.
A call for evidence on the first phase closed on 25 September and ahead of the official government response, portfolio institutional has collated views from key pension and investment industry stakeholders to garner appetite for initiatives that will drive local government pension schemes (LGPS) and defined contribution (DC) funds into UK assets.
Overstepping the mark
The Pensions Investment Review asks whether there is a case for establishing additional incentives or requirements aimed at raising the portfolio allocations of DC schemes and LGPS funds to UK assets.
If the government were to incentivise trustees to take such in- vestment decisions on their members’ behalf, there are immediate questions about a potential conflict with fiduciary duty.
Lizzy Holliday, director of policy and public affairs at master trust Now Pensions, says: “Trustees ultimately bear the responsibility to ensure that an investment is in the best interests of the members within the scheme, and we consider this system provides the appropriate safeguards for members.
“It’s essential that government interventions don’t overstep the mark by assuming the role of trustee,” she adds. Holliday continued to explain that formulating policy which influences pension investment strategies is inherently complex and warns that overly prescriptive measures that limit trustee decision-making raise questions about accountability for outcomes and redress.
“Policymakers should also be mindful of the broader market impact, such as inflating prices artificially and causing asset bubbles,” she says.
This is a view shared by Lorna Blyth, managing director of investment proposition at Aegon, who says that UK pension funds have long sought global diversification in portfolios, stating that reintroducing a home bias in default arrangements “would be a bold move for trustees or group person pension providers”.
“Any new incentives or requirements must be carefully considered, such as potential unintended consequences, long-term outlooks and the potential to further complicate pension scheme legislation, including tax implications,” Blyth says.
“Incentives must align with fiduciary duties and consumer duty requirements,” she adds. “Trustees generally oppose being forced to invest their scheme assets in a particular way if it is not in the members’ best interests.”
Fewer sticks
The government is clear that it wants UK pension schemes to invest in all UK assets including publicly listed equities. However, there is an undeniable emphasis on encouraging funds to make greater allocations to private assets, such as infrastructure, private equity and debt.
What is not clear however is whether Reeves supports the position of former chancellor Jeremy Hunt who proposed that pension funds be “encouraged to invest at least 5% of their assets in unlisted equity”.
This is not a recommendation favoured by Justin Wray, interim head of defined benefit (DB), LGPS and investment at the Pensions & Lifetime Savings Association (PLSA), who says: “In terms of increasing UK investment, we strongly prefer incentives rather than mandating how much is invested. Requiring a proportion of assets to be invested in the UK would be sub-optimal.”
Consternation about more draconian pension policy is also shown by Robert McInroy, head of LGPS client consulting at Hymans Robertson, who warns that should public pension schemes fail to support the government’s position on UK investment “there is a potential for more interventionist policy”. “As a public sector pension scheme, the LGPS would likely be seen as ‘low hanging fruit’.
Options could include mandatory UK investment levels or enforced restructure, both of which would cause significant upheaval and potential unintended consequences,” McInroy says.
More carrots
If the government is to have any hope of attracting UK pension schemes to invest on home turf, numerous reforms and incentives are needed.
Historically, DC schemes have been forced to focus on cost rather than value in their decision-making. The imposition of a fee cap for default investment strategies being a case in point.
The review asks whether a more consolidated LGPS and workplace DC market, combined with an increased focus on net investment returns rather than costs, would increase allocations to UK private markets.
Overall, commentators believe that prioritising value for money over cost would encourage DC investors to diversify into illiquid assets, and notes that such a framework is already under consultation with the Financial Conduct Authority.
Mark Jaffray, head of DC consulting at Hymans Robertson, says: “Private markets tend to have much higher management fees and their inclusion is likely to lead to higher ongoing charges for DC schemes and members. Assuming investment in high quality private market managers and assets, the addition of these investments to a DC portfolio could improve the net of fees returns and improve diversification which could reduce overall volatility.”
However, Now Pensions’ Holliday says that “competitive tenders are being won or lost on small fee differentials”, and she would like the government to be bolder in the value for money proposals.
“For example, introducing an additional forward-looking return metric, otherwise the increased cost is emphasised over the anticipated greater net of cost returns of private market investments which may take some time to show through. We would also like to see clarification on how these increased costs could impact on the risk of becoming an ‘amber-rated’ scheme, especially before returns are realised.”
There are additional caveats raised by Yona Chesner, head of investment in the North at consultancy Cartwright, who says: “Moving towards a more returns-driven approach can help solve the issue, however that comes with some risks.
“Key among these is overpaying for artificially complex solutions that don’t drive additional value,” he adds. “To mitigate this, we believe that ensuring appropriate levels of governance and independence of advice is a vital part of broadening out the opportunity set.”
Unintended consequences
Alongside turning attention from cost to returns, the government has other options to incentivise pension schemes to invest domestically. First is a lighter tax treatment for pension schemes investing in UK assets.
However, Aegon’s Blyth says this would likely come with a stipulation that a certain percentage of assets be invested in a particular asset class, such as UK equities, listed and unlisted, which as noted is unpopular with the industry and “could back-fire if the asset class underperforms”.
The PLSA’s Wray also recommends government provides policy and regulatory certainty to improve the UK’s appeal versus investment opportunities globally.
This includes developing a long-term strategy for investment and growth, outlining the government’s priority investment sectors, its approach to blended finance and how it will work with the pensions industry.
In July, Reeves announced the £7.3bn National Wealth Fund (NWF), which she says does exactly this, by aligning the UK Infrastructure Bank and the British Business Bank to provide a single point through which pension schemes can invest in domestic assets.
Reeves said the government will bring forward new legislation when parliamentary time allows to cement the NWF in statute, making it a “permanent institution at the heart of the country’s long-term growth and prosperity”.
Hyman Robertson’s McInroy says the government could consider LGPS-specific incentives for schemes that invest in the NWF, alongside other inducements including the removal of stamp duty, or ability to reclaim elements of tax, reducing the cost of UK investing and increasing returns.
“We acknowledge that incentives may cost money upfront but would underline the government’s commitment to growth policies and, if successful, lead to higher tax revenues after incentivisation periods,” McInroy says.
Essential investment
Whether schemes are encouraged or forced to invest domestically, the government is hugely reliant on the £830bn of assets held by private sector DC and public sector pension schemes if it is to stand any chance of driving growth and meeting its net zero by 2050 targets.
The Climate Change Committee says £50bn of investment is need every year between 2030 and 2050 to achieve a successful green transition.
Meanwhile, an EY report published in October estimates that the UK faces an infrastructure spending shortfall of at least £700bn by 2040. Closing this deficit without government spending would require private sector investment to more than double by 2040.
Philip Brown, director of policy and external a airs at the £40.6bn National Employment Savings Trust (Nest), says such funding gaps makes the UK an “excellent opportunity” for long-term investors who benefit not only from returns but from the improvements made in their home country.
“With greater investment in private assets, the question becomes ‘and why not in the UK?’ A growing UK economy benefits our 13 million members and their pensions, so it’s logical to explore our home market for private market assets.
“Our research shows that excellent UK investment opportunities exist across asset classes, particularly in property, corporate lending and infrastructure, and have specific UK-focused mandates in place to help us deploy money here,” Brown says.
Nest already invests more than £8.5bn in the UK, a significant portion of which is through illiquid assets.
Brown says the trust “only expects our UK allocation to increase over the coming years” and Nest will continue to explore new opportunities, where it can “achieve the twin objectives of finding great investment opportunities and supporting UK economic growth”.
However, he adds it is the government’s responsibility to provide a continuous pipeline of investment opportunities so that Nest can maintain an asset allocation.
Joined-up thinking
Politicians are often accused of treating the UK pension system as a political football, and commentators are keen to see that the latest round of potential reforms improve the regime rather than complicate it further.
Holliday says the push for scale and consolidation under the first phase of the review has “significant pensions-market altering implications with consequential impacts for members”. She adds: “We would like an open discussion with government about its specific ambition for the size and shape of the market, and the relevant mechanisms, regarding this aspect of its policy interventions.”
Members interests must be “front and centre”, Holliday continues, pointing out that since not all schemes are alike – not all are open for all employers, and a large proportion of auto-enrolment savers and smaller employers are served by a small number of large schemes – “it is essential to have assessments of how policy proposals are impacting the different and specific segments of the market”.
Brown agrees that members’ interest must be paramount in any investment consideration, but believes financial factors “can, and often should, include broader economic considerations, such as climate change, improvements to UK infrastructure, and support for successful British companies that employ and provide services to UK workers”.
The government will be under pressure to push through reform and shore up capital as quickly as possible to plug funding gaps. Yet rushing policy decisions could prove counterproductive. Working closely with those on the pension frontline and listening to the industry will be essential if the government is to achieve its ‘new era for economic growth’.
Comments