Rachel Reeves’ Mansion House speech last November was not without ambition, promising “the biggest pension reform in decades”, and two public consultations on what this means in practice close within days.
As part of her “invest, invest, invest” mantra to boost growth, the chancellor’s autumn budget announced £100bn of capital spending over the next five years. To increase this without spooking the gilded market horses, Reeves wants to merge pension funds into “mega funds”, which then invest more in the UK’s “private assets” – venture capital and infrastructure.
This “increase” applies to both the £400 billion defined benefit scheme for local government staff in England and Wales (Scotland’s £60 billion local government scheme is not included) and defined contribution (DC) pensions in workplace for private sector employees. The government also wants DC pension savers to hold more in UK shares.
Political rhetoric aside, it appears that these “reforms” are based on incomplete and flawed analysis.
For DC workplace pension funds, the government wants a minimum size of £25bn, and possibly up to £50bn, with fewer “default” investment options. It is significant that the changes will not come before 2030, beyond the date of the next general election.
The UK currently has around 30 ‘master trusts’ authorized 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 up to £25 billion is weak and its comments on Canadian pensions and Australian are selective or irrelevant.
For example, all of the Canadian “Maple 8” pensions that Reeves is so interested in are either public sector defined benefit schemes – including Ontario’s three 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, Australia’s DC “super funds” are bigger in absolute terms than the UK’s DC pensions, but they’ve been running much longer and have much higher annual contributions (meanwhile, the UK government is delaying a review in the increase of the minimum amounts of automatic registration). But Australia is also much less concentrated than the UK, with the 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, apart from a patriotic glow, like buying war bonds?
Analysis by the Government Actuary’s Department published to support the Mansion House speech is not encouraging. He concludes that the potential risk-adjusted returns for DC savers if they switch from holding international stocks – particularly US – to UK stocks and private assets, are about the same. Any difference over 30 years of regular savings is lost in rounding.
Since the potential returns are identical, DC savers should make their investment decisions on the second-order basis of international diversification maximization and cost minimization.
UK stocks represent 4 percent of the MSCI World Index – US stocks, dominated by big tech companies, make up 70 percent. But the UK equity allocation to DC pensions is already 8 per cent, double the “neutral” weighting.
There are good reasons for UK investors to be overweight in the UK – lower management fees and costs, no need for sterling currency hedging and many UK companies operating overseas, offering anyway an international diversification.
The chancellor could always tip the scales and give a subsidy to UK shares, restoring the dividend tax credit abolished in 1997 by a previous Labor chancellor, Gordon Brown. The main reason for Australian savers to hold Australian shares appears 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 that invest in their businesses?
In terms of minimizing management costs, fees for private UK assets are much higher than for public, passive equity trackers. Adding insult to injury, performance fees, paid on top of annual fees, are exempt from the 0.75 percent auto-enrollment fee cap.
Meanwhile, the new pensions minister, Emma Reynolds, has also given us a stark warning that “the government could force pension funds to invest more in UK assets”. It does not explain how this might work in practice, however, given the statutory and customary fiduciary duties of pension trustees to act in the “best interests” of their members.
She has hinted that the government may reduce tax breaks for overseas investment, likely to undermine confidence in pension savings, which are fragile at the best of times.
Over the years, various overseas governments have tried to dictate how pensions should be invested, none of which have worked well. Let’s hope the Labor government quietly drops the idea of ”forcing” UK pension funds to invest in the UK.
John Ralfe is an independent pensions consultant. X: @johnralfe1
