The practice of derisking defined contribution pension pots as savers close in on retirement will cost the U.K. as much as £25 billion ($32 billion) during the current Parliament, according to asset manager Columbia Threadneedle.
Cautious investment strategies are undermining government efforts to drive funding into U.K. listed companies, startups and infrastructure, Columbia’s head of dynamic real return Christopher Mahon said. The arrangement, — known in the industry as “lifestyling” — is a hangover from before “pension freedoms” reforms in 2015 and is “costing savers and the country excessively,” he said.
In November, Chancellor of the Exchequer Rachel Reeves pledged “to power growth in our economy” by consolidating smaller defined contribution plans into Canadian and Australian-style “megafunds.” A culture of risk-aversion in the U.K. investment industry has gone too far, she added.
Reeves wants smaller pension funds to merge into £25 billion funds to cut fees, spread risk and enable them to deploy larger amounts of capital into major U.K. projects, which would help the economy and improve returns for members. Savers are losing £12,000 on the average-sized £107,000 pension pot over five years due to “lifestyling” risk-aversion, Mahon said.
Last month’s interim Pensions Investment Review noted that Britain’s “£3 trillion pensions industry has the third-largest stock of assets in the world” but said “the government is concerned that U.K. pension funds are investing significantly less in the domestic economy than overseas counterparts.” London, which was once a premier venue for public listings, has fallen to 20th place in a ranking of global IPO venues as domestic pension funds shun the U.K.
In a sign of government frustration, Reeves has refused to rule out forcing funds to invest a fixed proportion of assets in the U.K.
Louis Taylor, chief executive of the state-owned British Business Bank, said one idea was to make funds repay pensions tax relief if they fell short of a U.K. asset allocation threshold. Pension tax relief is worth around £50 billion a year.
Mahon welcomed Reeves’ consolidation plans, but said a simpler “lifestyling” change could be more effective.
In Australia, where returns and domestic investment are significantly higher than in Britain, two-thirds of plans avoid “lifestyling,” according to data from the Australian Prudential Regulation Authority and Pension Policy Institute.
Under lifestyling, pensions are gradually derisked over the five to 10 years before retirement, with equity allocations reduced on average from 75% to 25% in favor of bonds and cash, according to Mahon’s analysis.
Derisking worked when people were required to buy an annuity on retirement, but the rule was scrapped in 2015. Even so, “nearly all defined contribution schemes use the approach” and regulators “tacitly endorse” it, Mahon said.
Older savers typically have 4% of assets in the U.K. stock market compared with 9% for younger savers, Mahon calculated from official data. The Pension Policy Institute has estimated that defined contribution plan assets will grow to £1.3 trillion by 2030, two-fifths of which are held by older savers.
Maintaining the 9% asset allocation in U.K. companies for older savers would release £25 billion for productive investment by 2030, Mahon said. His analysis showed that “size makes little difference” to returns for schemes above about £10 billion. “Cutting costs is a help, but no cure for this regulation-driven risk aversion,” he said.
