U.K. investors challenged to invest at home

When U.K. leaders called for domestic pension funds and other investors to look beyond the stock market and invest more in British infrastructure and other long-term domestic assets, they received a polite but muted response.

In an open "challenge" letter published Aug. 4, Prime Minister Boris Johnson and Chancellor of the Exchequer Rishi Sunak said global investors, including pension funds in other countries, benefit from U.K. long-term investments while U.K. institutional investors are underrepresented.

For example, they noted 80% of U.K. defined contribution plan assets are mainly in public securities that represent only 20% of U.K. assets.

The pitch is part of the U.K. government's Build Back Better strategy for recovering from the COVID-19 crisis. "To seize this moment, we need an investment big bang, to unlock the hundreds of billions of pounds sitting in U.K. institutional investors and use it to drive the U.K.'s recovery," Messrs. Johnson and Sunak wrote. "We strongly believe this is a question that all institutional investors should be considering."

Mr. Johnson is hosting an investment summit in October to continue pressing his case. And it is a reasonable ask, in principle, institutional investors said.

"Opening up private markets for long-term investors like pension schemes is a win-win," said Mark Fawcett, CIO of the £19.4 billion ($26.9 billion) defined contribution multiemployer plan National Employment Savings Trust, London, in a statement on the letter.

"It allows schemes to access potentially strong, steady returns for decades, while helping to support economic growth and job creation that should ultimately also benefit our savers," he said.

NEST has been steadily increasing investment into private markets as its assets grow and will make its first private equity commitment later this year. By 2030, it expects to invest nearly £3 billion in infrastructure, which would amount to 5% of its portfolio.

"We support the government looking at innovative ways to help other schemes access similar return opportunities," Mr. Fawcett said.

That will be the tricky part. "Any framework designed to use pension assets needs to offer a level of risk-adjusted return at least as good as returns available elsewhere. This is a circle which the government will have to square," said Pete Glancy, head of policy for pension manager Scottish Widows, Edinburgh, with £140 billion under management. "If a way can be found to use pension assets to create better jobs and more successful businesses, that could be great news for pension savings in the long run," Mr. Glancy said.

The government will also have to make it easier for retirement assets to be invested in less-liquid assets, many observers said.

"Trustees are willing to invest for the long term but need the government to remove the barriers to this type of investment and to help ensure there are suitable projects to invest in," said Myles Pink, partner at Lane Clark & Peacock LLC in London.

"Trustees are increasingly seeking stable returns from U.K. businesses and projects that focus on balancing commercial success with long-term sustainability and social responsibility," Mr. Pink said. "This must be more than just warm words from government."

One welcome bit of news came when The Pensions Regulator decided to scrap a controversial proposal that would have limited defined benefit plans' illiquid investments to 20% of portfolios. Instead, TPR said, trustees may consider allocations for diversification, positive risk-adjusted-returns and higher-yielding long-duration inflation-linked income streams.

The U.K. Build Back Better initiative includes a 10-point plan for a green industrial revolution and a new U.K. infrastructure bank to co-invest in green infrastructure. In September, institutional investors can access the first green gilt to help fund green commitments. Later this year, regulators are expected to approve the Long-Term Asset Fund, a new fund structure aimed at allowing U.K. pension funds to invest in illiquid assets.

Those measures should help facilitate investment in long-term infrastructure, the Pensions and Lifetime Savings Association said in a statement on the challenge letter. Still, it cautioned that the U.K. pension sector representing more than £2 trillion in retirement assets "is not homogeneous," and investing in illiquid and alternative assets "can often be more complicated, more costly and more resource-intensive."

According to the British Private Equity & Venture Capital Association, U.K. pension funds account for less than 5% of assets in British venture capital and private equity funds, which notched 10-year annual returns of 14.2% in 2019, compared to 8.1% for the FTSE All-Share index over the same period.

The challenge could also be a boost for superfunds able to provide the scale and resources necessary to make long-term investments, said Adam Saron, CEO of defined benefit fund consolidator Clara-Pensions in London.

Whether it really moves the needle is another matter. "From what we see, U.K. DB pension schemes have already been fairly keen to increase their allocations to U.K. infrastructure and other non-listed assets, driven by the ability to access sterling-denominated, stable cash-flowing assets; to take advantage of the illiquidity premium and diversification benefits; and to access assets with attractive ESG characteristics," said Paul Jayasingha, global head of real assets manager research for Willis Towers Watson PLC in London.

"Many of our clients have been keen to transition to lower carbon-intensive portfolios and illiquid assets, especially infrastructure, has been a great way to enable this move. So, generally, I wouldn't regard a challenge as being necessary," Mr. Jayasingha said. He did welcome the letter's recognition of making it easier for defined contribution plans to invest in illiquid assets.

The £82.2 billion Universities Superannuation Scheme, London, "is already an active supporter of the principles behind 'investment big bang,'" with 40% of assets invested in the U.K., including roughly half of the £23 billion allocation to private markets, said Simon Pilcher, CEO of USS Investment Management, the in-house manager for the pension fund. "Amongst U.K. pension schemes, we are, by a distance, the biggest investor in private assets," he said.

"We share the government's view that there is an opportunity to drive growth and prosperity by investing in the U.K., securing the returns that will enable USS to pay the pension promises," said Mr. Pilcher, who added that USS officials "expect to continue to have positive engagement with government and regulators as they seek to ensure there is an environment that encourages investment."

When those conversations do happen, said David Vickers, CIO of the £30 billion Brunel Pension Partnership, Bristol, "the onus is now on the government to ensure it invites leading U.K. pension funds to the consultation table, so that new initiatives are fully accessible to our own funds — not just to international investors."