UK Chancellor Jeremy Hunt used his annual Mansion House speech to lay out proposals for far-reaching and complex reforms to pensions and investment in the UK.
The speech launched a series of consultations to drive a profound shake-up of the UK’s pensions market. Speaking in the City of London, Hunt presented his three “golden rules” to provide a framework for future reforms.
The consultations hope to provide an “evolutionary” rather than “revolutionary” change. Hunt said he wasn’t looking for “Big Bang II.” By ushering in a better funding environment, the government hopes to prevent further losses on the London Stock Exchange, boost infrastructure and start-up funding, and improve returns on retirement savings.
The headline goal is to see pension funds putting 5% of their investments in UK private equity and early-stage businesses. Crucially, the government has recognised that mandating this would be a mistake. A voluntary pledge to meet this target has already gained significant traction. Big names including Aviva, Legal & General, Phoenix, and Scottish Widows have already signed up.
Alongside this, further reforms would dramatically alter the market in other ways. Notably, the government hopes that smaller, inefficient, pension funds will merge to become “superfunds.” Similar funds internationally are hailed as examples of the potential to increase investment in infrastructure and high-growth businesses.
Why does the UK government want to reform pension funds?
The government has made no secret of its desires. UK financial markets have been performing comparatively poorly against international rivals for years. Pension funds could provide vital investment.
Alice Guy, head of pensions at interactive investor, notes that defined benefit (DB) pension schemes have reduced their exposure to UK equities from about 50% in the 1990s to less than 2% in 2022. “This mass exodus from UK equities has arguably contributed to lagging UK equity prices.”
According to Bloomberg, equities listed in London have dropped from a record total capitalisation of $4.3 trillion in 2007 to around $3 trillion today. This compares with US stocks doubling to a capitalisation of $46 trillion over the same time.
Overall, the UK stock market has been on a downturn since 2017. Based on forward price-to-earnings ratios, stock valuations in the UK are at a 40% discount compared to developed market rivals internationally. Last year, Paris pipped London to become Europe’s biggest stock market. Indeed, London now ranks seventh in the global equity market behind the US, China, Japan, Hong Kong, and India.
With lower valuations and a weak currency, the UK government are clearly concerned. Companies such as ARM are increasingly looking across the pond when they decide where to list. It also makes the current market attractive to foreign ownership looking for good deals. The government would prefer things stayed at home, so to speak.
Tapping into pension funds is touted as a way to increase the UK stock market valuation and retain national ownership. A win-win in government policy thinking.
Pension funds to invest in UK’s future growth
Nick Lyons, Lord Mayor of London, is one of many voices calling for a “future growth fund” of £50 billion by 2030. To reach that target, they envisage compelling direct contribution (DC) pension funds to invest in it.
There is a logic here. Estimates are that investment managers hold around £3 trillion in assets but are risk averse compared to international equals. This has led to proportional holdings of UK equities dropping from 50% to just 10% in the last 15 years. At the same time, holdings in bonds have risen from around a third to 70% now.
Lyons wants this new fund to be “as good as it can be… world-leading so it sits alongside the likes of Sequoia Capital as a globally acknowledged specialist in the area of late-stage venture capital for tech companies”.
Greg Smith, CEO of IP Group, a British-based fund investing in tech companies, concurs. “Pension funds from the US, Canada, Australia, and Japan have long known that investment into innovative UK companies can offer returns that beat bonds or other asset classes hands down… What’s more, much of this has been tried and tested before. In the US, 65 per cent of Venture Capital fundings comes from public pensions.”
Chris Cummings, Chief Executive at the Investment Association, also sees the benefits to reforms unlocking increased investment in the UK market, “…investment must be at the heart our economy – providing for the financial futures of UK households through pensions that deliver good returns, even in the most challenging economic times, and powering growth by investing in British businesses… With the right regulatory framework, pension schemes will be able to invest productively and sustainably, unlocking further investment for innovative growth companies, and improving returns for savers by broadening investment options.”
Consolidating the UK’s smaller pension funds
The Tony Blair Institute for Global Change is arguing for the consolidation of smaller private and public funds into “superfunds.” The vision being that they would then have the scale to make these kinds of investments inside the UK themselves. This aims to replicate the experience of pension superfunds in Australia and Canada.
Since 2012, auto-enrolment into pensions has seen a massive increase in the number of people with retirement savings. However, this has indeed led to a disparate array of smaller funds. Moreover, many people have lost track of their pension pots with potentially £26 billion in “lost” funds floating around. Proponents argue that these new superfunds would provide the capital needed and go some way to resolving these issues.
Financial services lobby group TheCityUK, backs the proposals. “On average, Australian and Canadian pension funds currently provide better performance. We need to follow their example, encourage consolidation of schemes and deliver better retirements, which will also support growth,” it said in the lead up to yesterday’s announcements.
David Livingstone, Citi’s CEO (EMEA), added his voice in support of the move. “Based on Citi’s experience working with investors and pension funds around the world, consolidating funds often increases efficiency and improves access to global, diversified investment opportunities, which would be immensely beneficial to the UK, home to the second-largest pool of long-term capital in the world.”
What can we expect pension reform to actually happen?
Pension reform in the UK often feels like tomorrow. Always coming but never arrives. Under the current government, pension reforms seem to move at snail’s pace.
There’s the Value For Money (VFM) framework to provide clearer data. The dashboards to bring that data into one clean, user-friendly system. Consolidating smaller funds into superfunds. “Encouraging” pensions to invest in UK assets.
How many of them have happened? None. Many believe that in terms of serving the public and increasing engagement with retirement savings, the VFM and dashboards are vital. They started around 2016. 7 years later and there seems little to show for it, and little on the horizon either.
Yesterday’s proposed reforms are not exactly hot news either. The “future growth fund” and consolidation of small players have been discussed for years. So, while they could indeed provide much needed investment in the UK, exactly when that might happen remains an open question.
The chancellor is expected to expand on yesterday’s comments in his Autumn Statement. But, with a government crippling itself in culture wars externally and civil wars internally, regularly 20+ points behind in the polls, and no appetite for real legislation, it seems likely we’ll be waiting a lot longer than that for any real action. Having said that, Labour Shadow Chancellor, Rachel Reeves, is said to back the reforms so we shouldn’t expect them to disappear competely under a new government next year either.
While the timing of change may be up in the air, market sentiment does appear to be getting behind the plans. David Postings, Chief Executive of UK Finance said: “We welcome the plans announced by the Chancellor in his Mansion House speech, alongside his ongoing commitment to ensuring the UK has a strong and globally competitive financial services sector. These reforms will help support economic growth and bolster our capital markets by delivering more investment and making it easier for companies to grow and list here in the UK.“
Author: Mike Davies
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