The Chancellor of the Exchequer, Jeremy Hunt, has set out proposals for the UK pension fund industry in his speech at Mansion House. These proposals focused on three of the UK government’s priorities: invest more in the UK economy, in the name of increasing productivity, infrastructure and ‘levelling up’. The plan seems to be to alter the asset allocation of pension funds to help achieve the government’s targets, as well as scaling up the size of UK pension funds to improve efficiency and increase capabilities.
However, there are two main criticisms. First, much of what is proposed is already taking place. The government’s arguments in favour of larger pension funds is widely accepted and in recent years, public sector pension funds in the UK have consolidated into eight pools. A further forced consolidation, at this time, would be highly disruptive.
The proposals place great emphasis on investing in private equity and infrastructure over publicly quoted companies. Fortunately, there has been and continues to be great enthusiasm from UK pension funds to invest in private assets of all descriptions – private equity, private debt, infrastructure and niche areas of real estate. There are definitional issues here as the consultation document tends to identify private equity with high-growth and venture capital companies. However, if money committed to unlisted infrastructure equity is included, then many local government pension scheme (public sector) funds have already surpassed the consultation’s ambition of a 10% commitment to private equity.
Second, Hunt does not appear to have fully accepted the realities of investment management in the UK pension fund industry. For example, his approach is understandably UK-centric as he wants to boost investment domestically, but institutional pension funds and companies tend to invest and operate globally.
No longer do UK pension funds typically allocate so much to be invested in UK and so much in foreign equities. Instead, they award global mandates to the fund managers. Admittedly, there can be more of a regional grouping in private equity but this is likely to be into a European, not a ‘UK only’ fund. It would be interesting to know how UK-specific the funds used by the Department of Works and Pensions to calculate the anticipated excess return from investing more in private equity are.
An issue is whether there is a sufficiently large pipeline of attractive, UK-listed high-growth companies to satisfy the chancellor’s suggestion of investment of £50bn-£75bn in these stocks by 2030, especially as the emphasis is on venture capital. There is also the issue of limiting the geographical diversification of risk. In recent years, UK pension fund members have benefitted greatly from diversifying away from the underperforming UK equity market.
But perhaps the most worrying aspect of the consultation is the assumption that greater investment in private equity, venture capital and small- and medium-sized enterprises will produce higher returns for pension funds. While this may well turn out to be the case, it is not inevitable, as implied in the consultation document. For example, leveraged buy-out funds, which have formed a sizeable part of the private equity asset class, have historically benefitted from the multi-decade fall in bond yields. This will not be a tailwind in the future.
The Government Actuaries Department’s modelling output is being used to justify the proposals. However, it does not show improved returns if private equity investment on current fee scales is financed by selling quoted equities. A modest improvement in return is achieved if corporate bonds are used as a source of funding but this will very likely increase portfolio risk. The illustration, which does show an improvement in return when quoted equities are used as a source of funding, relies on long-established fee scales being halved.
The consultation also intriguingly proposes that LGPS pension funds should make a direct contribution to the government’s ‘levelling up’ initiative by investing 5% of their assets ‘in projects which support local areas’. Apart from potentially producing conflicts of interest (even if ‘local’ can be anywhere in the UK, not just in your own neighbourhood), it is hard to believe that LGPS pension funds with their limited resources are better placed than the government or the corporate sector to determine which parts of the UK need to be favoured.
It is customary in the UK for the government of the day to seek to achieve its agenda through fiscal policy. Better directed public spending, changes to the taxation system and incentives for the private sector have been tools of choice. But the proposed direction of pension fund investment policy is quite the departure from the norm. At the most fundamental level, it could start to strip the accepted fiduciary responsibility from pension fund trustees.
Colin Robertson is the Independent Adviser to several pension funds and a former Global Head of Asset Allocation at Aon.
