It is often alleged that one of the barriers to UK growth is a lack of capital available for investment. That is a bit of a puzzle, in part because international capital is highly mobile; and in part because, unlike most other European countries, we have a massive private pension system sitting on some £2 trillion of assets.
With an eye on that vast sum, both this government and its predecessor have been asking themselves what could be done to move more of those assets into what they call “productive investment” in the UK. That seems to mean providing equity capital and finance for start-up and scaling UK businesses, domestic infrastructure projects, affordable housing, and promoting longer-term and more illiquid investments.
The focus is on defined contribution pensions. While old-style defined benefit schemes still have more than half of that £2 trillion, they have moved, with only a few exceptions, almost entirely into investing in government debt and other “safe” assets. That’s been partly driven by regulation and partly by the fact that most are now closed to new members and are gradually running down. They are the past. The defined contribution or DC sector, powered by the success of automatic enrolment, is the future.
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From the point of view of a government wanting more investment in the UK, that sector has proved something of a disappointment. Back in 2012 around half of DC pension assets were invested in the UK, with 30 per cent in UK equities. Today, though, just 6 per cent of DC scheme assets are in UK equities. Only a tiny fraction is invested in unlisted companies and start-ups, via venture capital, for example.
By contrast, big Australian and Canadian pension schemes are much more domestically focused and have more exposure to both infrastructure funds and venture capital. Looking at these facts, UK ministers have come to the conclusion that something needs to be done to get more of these funds into “productive” investment. They have started with encouragement and “voluntary compacts” to nudge funds into different investment choices. This government is becoming rather more dirigiste. The pensions bill currently going through parliament contains powers that would allow ministers to compel pension schemes to invest a minimum fraction of their assets under management in certain assets.
This approach raises a number of questions. It could lead to a major government intervention in a private market. What’s more, it’s a market on which most of us rely for our future welfare. There can be little doubt that those of us with our pensions invested in a global tracker over the last few years have done better than we would have done had we been more domestically invested. Any government needs to be pretty confident of its grounds for directing private investment decisions before wading in, and pretty confident that other less radical interventions wouldn’t work. The evidential barrier here should be high. A new paper written by myself with colleagues at Frontier Economics, and with pensions experts at Lane Clark & Peacock, looks at the evidence.
There clearly are potential problems in this market. Providers struggle to compete on anything other than the prices they charge for investing assets. That means that it can be hard to make a case for investing in private markets where returns might be higher because the costs of doing so are higher. It might also be the case that if pension providers could co-ordinate their actions to invest in certain assets, that would lead to greater economic growth and hence better returns for all.
Looking at these potential market failures, comparing UK investment patterns with those in the likes of Australia and Canada, constrained in the use of government money to boost growth, and frustrated by lack of voluntary progress, ministers have decided they need to be able to direct how pensions are invested. At present they say this is merely a “reserve power” to be used only in the case that voluntary accords fail. How voluntary those accords really are if such a threat hangs over them
is a moot point.
There are other interventions that the government is making with similar objectives. These include the British Business Bank and the National Wealth Fund, both designed to increase investment in “productive assets”. Policies specifically aimed at DC pensions are making it easier for them to invest in private assets while maintaining required levels of liquidity. A new value for money framework is being designed to help reduce the salience of cost alone.
Perhaps most importantly, government is requiring that most default funds should have assets under management of at least £25 billion by 2030. This should accelerate consolidation in the market, with funds growing fast in any case as automatic enrolment matures. This really matters. Bigger funds are much more able to invest in more complex markets. Indeed, one reason among many that it is misleading simply to compare current asset allocations by UK funds with those by Australian and Canadian funds is that the latter are much bigger. As UK funds scale up, it is likely that investment portfolios will change towards more investments of the kind the government desires.
Given all this it is, at best, premature to be taking such a radical step as to give ministers the power to override the fiduciary duty of trustees. For this is a radical step indeed. It establishes the principle that it is appropriate and desirable for governments to tell schemes how to invest. No doubt current ministers believe that they would only ever use such powers for what they see as benign and virtuous
purposes. That does not mean that the outcomes will be benign. And is it so hard to imagine that future ministers might apply the same principle, even the same legislation, for less benign purposes?