Retirements aren’t typically considered the sexiest topics of conversation. But suddenly MPs from both of Britain’s main parties are falling over themselves to talk about it. The penny has finally dropped on just how massive the nation’s retirement savings are about £3 trillion — one of the largest in the world — could be used more productively to boost the UK’s long-term economic growth prospects. The majority of total pension assets are invested in low-risk, low-return bonds. Releasing just part of that for long-term investment in promising UK companies and infrastructure projects would boost productivity.
The consensus on finding ways to make Britain’s pension assets sweat harder is welcome. The average UK equity allocation by UK defined benefit plans — which provide retirees with a defined income — has fallen from almost 50 percent in 2000 to less than 2 percent today. This has undermined the London Stock Exchange. But since reversing this trend involves shifting the savings of millions of individuals to riskier and less liquid assets, albeit likely with higher returns, how this is achieved is important.
The Conservative government has not ruled out funds being mandated to invest more in the UK – something the opposition Labor Party recently suggested it could support. Force is not the right approach. Investment decisions must be made in the interests of savers, and effective risk management requires freedom from other constraints. The ability to invest in global assets also provides important channels for diversification. Instead, policymakers should focus on increasing the low incentives pension funds face to invest primarily in UK assets.
Defined benefit funds have traditionally been the dominant form of pension. Accounting changes in 2000 that forced companies to record deficits or surpluses on their balance sheets spurred the shift to longer-dated and less risky fixed-income assets. With a surplus of more than £300bn in the fund, the rules could be revised to encourage investment in other asset classes. Supporting the consolidation of the UK’s more than 5,000 DB schemes could also create a better cushion for riskier investments.
With fewer DB plans open to new entrants or seeking returns, defined contribution plans, which provide retirement income based on individual investment, may be a better resource. They are expected to surpass £1 trillion worth of businesses by 2030, and already allocate most of the assets to stocks as they are not required to provide fixed returns. Again, bundling the plethora of small DC schemes could encourage greater investment in alternative assets. Reforming the pension cap, which is designed to protect savers from excessive compensation, could also provide greater access to managers investing in less liquid assets, such as unlisted equities and infrastructure.
The skills and knowledge of pension professionals will also need to be improved. Investing in riskier and more obscure asset classes, such as private companies and road and rail projects, requires specialized due diligence. Regulatory resources to monitor more complex investments will also need to be scaled up to ensure retirement savings are protected.
Ultimately, confidence in the economy will be the biggest drag on pension funds investing in UK plc. Political instability and the lack of an industrial strategy have encouraged short-sighted and risk-averse investments. A poor track record of delivering fruitful public investments in a timely manner does not help. Even if British pension funds are freed from regulatory pressures and armed with more sophisticated investors, there is no guarantee they will invest in promising companies or infrastructure projects in Britain without more capable and astute political leadership.
