Rachel Reeves’ Mansion House speech last November was not short of ambition, promising the “biggest pension reform in decades”, and the two public consultations on what this means in practice close in a few days.
As part of her “invest, invest, invest” mantra to drive growth, the chancellor’s autumn Budget announced £100bn of capital spending in the next five years. To raise this without frightening the gilt market horses, Reeves wants to merge pension funds into “megafunds”, which then invest more in UK “private assets” — venture capital and infrastructure.
This “bulking-up” applies both to the £400bn defined benefit scheme for local government staff in England and Wales (Scotland’s £60bn local government scheme is not included) and to defined contribution (DC) workplace pensions for private sector employees. The government also wants DC pension savers to hold more in UK equities.
Leaving aside the political rhetoric, it looks like these “reforms” are based on incomplete and flawed analysis.
For DC workplace pension funds, the government wants a minimum size of £25bn, and preferably up to £50bn, with fewer “default” investment options. It is significant that the changes wouldn’t come in before 2030, beyond the date of the next general election.
The UK currently has about 30 “master trusts” authorised by the Pensions Regulator, and another 30 “contract-based” providers, with combined assets of £480bn.
DC pensions certainly need a minimum asset size to spread fixed costs, and encourage good governance, but the government’s analysis of why the threshold should be as high as £25bn is weak, and its comments on Canadian and Australian pensions are selective or irrelevant.
For example, all of the Canadian “Maple 8” pensions that Reeves is so keen on are either public sector defined benefit schemes — including the three Ontario schemes for teachers, medical staff and local government staff — or are funding Canadian state pensions, so tell us nothing about UK DC pensions.
And yes, Australian DC “superfunds” are larger in absolute terms than UK DC pensions, but they have been operating much longer, and have much higher annual contributions (meanwhile, the UK government is delaying a review into increasing minimum auto-enrolment amounts). But Australia is also much less concentrated than the UK, with the top 10 largest schemes holding a much smaller proportion of total assets than the UK.
What exactly do DC savers get out of investing in the UK, other than a patriotic glow, like buying War Bonds?
Analysis from the Government Actuary’s Department published to support the Mansion House Speech is not encouraging. It concludes that the likely risk-adjusted returns for DC savers if they switch from holding international equities — especially US — to UK equities and private assets, are virtually the same. Any differences over 30 years of regular savings are lost in the rounding.
Since likely returns are identical, DC savers should make their investment decisions on the second-order grounds of maximising international diversification and minimising cost.
UK equities represent 4 per cent of the MSCI World Index — US stocks, dominated by the big tech companies, make up 70 per cent. But the UK equity allocation for DC pensions is already 8 per cent, double the “neutral” weighting.
There are good reasons for UK investors to be overweight the UK — lower management charges and costs, no need for currency hedging into sterling, and many UK companies operate overseas, providing some international diversification anyway.
The chancellor can always tip the scales, and give a subsidy to UK equities, by reinstating the dividend tax credit abolished in 1997 by an earlier Labour chancellor, Gordon Brown. The main reason for Australian savers to hold Australian equities seems to be the Australian dividend tax credit. Doing this in the UK would certainly be expensive, and surely it is better to give tax breaks directly to companies investing in their businesses?
As for minimising management costs, fees for UK private assets are much higher than on public, passive equity trackers. Adding insult to injury, performance fees, paid on top of annual fees, are excluded from the 0.75 per cent auto-enrolment fee cap.
Meanwhile, the new pensions minister, Emma Reynolds, has also given us a stern warning that the “government could force pension funds to invest more in UK assets”. She doesn’t explain how this could work in practice, though, given the statutory and common law fiduciary duties of pension trustees to act in the “best interests” of their members.
She has hinted that the government could reduce tax breaks on overseas investments, sure to undermine confidence in pension saving, which is fragile at the best of times.
Over the years various overseas governments have tried to dictate how pensions should invest, none have worked out well. Let’s hope the Labour government quietly drops the idea of “forcing” UK pension funds to invest in the UK.
John Ralfe is an independent pensions consultant. X: @johnralfe1
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