Ministers have been warned by industry experts to tread carefully when intervening where pensions are invested as the government pushes for more investment in the UK economy.
Frustrated by a perceived lack of low investment domestically, Labour are pushing for an increase in domestic investment, in areas such as infrastructure, high-tech companies and start-ups, both through savings and pensions.
The government have become increasingly frustrated by some major projects attracting funding from overseas pension funds.
In response, it has explored whether it might need to force schemes to invest in certain ways or introduce incentives backed by billions of pounds of public funding to shift investment patterns.
But critics have warned this could result in potentially risky consequences for workers’ hard-earned pensions.
A new report by Frontier Economics and pension consultancy LCP has urged the Government to beware ‘unwise interventions’.
The report, authored by former Institute for Fiscal Studies (IFS) director Paul Johnson and former pensions minister Sir Steve Webb, lists a number of things the Government should take into consideration before making such changes.
Johnson said: “Governments should act with great humility for fear of reducing the value of people’s pensions.”
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Warning over investment mandates
The report is particularly critical of powers in the Pension Schemes Bill that could allow ministers to mandate DC pension schemes to invest in private markets if voluntary commitments are not met by 2030.
The authors argue there is no clear case for overriding the judgement of trustees, who are legally required to act in the best interests of pension members.
Webb said international comparisons often used to justify stronger government intervention fail to reflect the differences between pension systems.
He said: “We need to move away from spurious comparisons with the pension systems of other countries when deciding what is right for the UK.
“The Australian defined contribution system in particular is currently far larger and far more mature than the UK system and this will inevitably lead to a different investment mix compared with the UK’s smaller sector.
“The UK investment mix will in any case shift rapidly in the coming years, as UK DC schemes grow rapidly.”
For that reason, he said ministers should avoid imposing their own investment strategy on pension schemes.
“The Government should not be in the business of over-riding trustee decisions to impose what it thinks is the right answer.”
Others have agreed. Baroness Ros Altmann, a former pensions minister, said: “These dangerous proposals need to be amended to protect ordinary workers’ pensions – the Government does not know best how to invest.”
The size of pension schemes can shape investment choices
One of the key findings of the research is that differences between the UK and other countries often used as examples of delivering stronger domestic pension investment may not reflect reluctance among British schemes.
Instead, the report argues that scale is the main factor. For example, in countries like Australia, pension schemes tend to be much larger and more mature.
As such, it allows them to diversify more easily into assets such as infrastructure projects and private markets.
But the same trend is beginning to emerge in the UK as schemes grow.
And as the defined contribution (DC) sector expands, more schemes are expected to follow the same path.
Under DC pensions both the employee and often the employer make contributions into a personal pension pot. These contributions are then invested in a range of assets, such as stocks, bonds, and funds, with the goal of growing the value of the pension fund over time.
The report says the investment mix ministers are hoping to see could emerge naturally as the sector grows in time – and so further meddling may not be necessary.
The authors also caution against assuming that the investment patterns seen in other countries provide a blueprint for the UK.
Instead, they argue that policy should begin by identifying specific “market failures”, where the level of investment produced by markets alone falls short of what is desirable, and tackle those head on.
Calls for careful policymaking
Johnson, now senior adviser at Frontier Economics, said policymakers should approach pension investment reforms cautiously.
He said: “The UK’s growing DC pension sector is a great success and potentially a huge benefit for the economy as well as for future pensioners.
“Any government intervention in how those funds are allocated needs to be very carefully assessed.”
Labour has encouraged a voluntary agreement under which large pension funds commit to investing 5 per cent of their default workplace pension funds into UK private assets by 2030, alongside a broader target of 10 per cent for private markets overall.
Current estimates suggest that only around 4 to 5 per cent of DC pension assets are invested in UK equities.
Mixed view on current policies
Efforts to increase the scale of pension schemes are expected to reduce barriers to investing in assets such as infrastructure and private markets.
The authors support proposals that would allow pension providers to move poorly performing or outdated group personal pension policies into more modern arrangements with stronger investment strategies but they raise concerns about other policy ideas.
One proposal would introduce simple “value for money” ratings that place pension schemes into four broad categories.
A Government spokesperson said: “Our pension reforms will unlock billions of pounds for the UK economy, supporting businesses to grow and creating well-paid jobs across the country that put more money into people’s pockets.
“Pension funds have committed to private market investment targets in the UK voluntarily, due to the potentially higher returns and security for savers.”
“And thanks to our Pension Schemes Bill, an average earner’s pension pot could see a boost of £29,000, making pension pots work harder for savers.”