The U.K. government may have missed a step in its quest to unlock billions of pounds of defined benefit assets for investment into U.K. productive assets, sources said.
Not mandating more consolidation of public pension fund pools and not introducing tax incentives to encourage pension funds to invest locally are missed opportunities, they added — and without those changes, it's unlikely these pension funds could compete on the global investment stage.
On Nov. 14, the U.K. government unveiled its plans to inject about £80 billion ($100.9 billion) of assets into the country through an overhaul of the defined contribution market and tweaks to how local government pension schemes operate and invest.
In the months running up to the release of the government's interim review, industry players speculated on whether the government would force further consolidation of the 86 England and Wales LGPS funds, which together house about £360 billion and are forecast to have a total £500 billion in assets by 2030.
The pension funds have already brought together some of their assets into eight larger pools, following an initiative by the Conservative government in 2015. But sources had anticipated that Chancellor of the Exchequer Rachel Reeves might want those pools further consolidated to three or four — or even one — larger funds.
The latest announcement from the government looks to keep the basic architecture of the eight pools, but encourage even more pooling of assets, since the existing pools do not yet manage all of their member LGPS funds' money.
Border to Coast Pensions Partnership, Leeds, England — among the largest of the pools — was responsible for investing £52.3 billion of its 11 member LGPS funds’ assets as of March 31. That equates to about 82% of the member funds’ total assets, for example.
The government wants the following "minimum standards'' to be applied to the LGPS funds and pools: Overhaul LGPS fund governance to deliver better value from investment decisions; require each administering authority to specify a target for investment in its local economy; fully delegate the implementation of investment strategy to the pool and take principal advice on the investment strategy" from the pool.
In addition it wants all of the eight pools to be established as investment management companies. That means authorization and regulation by the Financial Conduct Authority, “with the expertise and capacity to implement investment strategies.”
As it stands, not all of the eight pools are FCA-authorized.
Encouraging U.K. consolidation
Even as the government pushes for more consolidation to facilitate investment in U.K. productive assets, such as infrastructure and other long-term investments, one pension fund expert said he isn’t sure that leaving the eight pools to run without further consolidation will be sufficient.
“These eight funds, in theory of about £50 billion (each), would not even be top 20 or 30” in terms of competing with the largest retirement plans in the world," said Gordon Clark, senior consultant and emeritus professor at Oxford University's Smith School of Enterprise and the Environment.
According to the Pensions & Investments and Thinking Ahead Institute ranking of the top 300 retirement plans as of Sept. 30, £50 billion — or the equivalent about $63 billion — would put these funds just outside the top 80.
“That’s a worry. I would strongly recommend they go from eight to four, and in that sense, they may well be competitive in terms of recruiting the best people, having sufficient assets to invest in technology, and generally being a sophisticated investor,” Clark said.
Anything less than the £78 billion Universities Superannuation Scheme, London, in terms of assets “would be a mistake — eight funds between £30 and £50 billion are subscale by international standards,” Clark added. “It would also be a real problem against the big American, Australian and Canadian funds in London, (with competition for) recruiting talent.”
U.K. pools of that size would also risk being the “junior” partner in any consortium to invest in infrastructure, he added.
On the technology side, “size is really important for innovation. Technology is rapidly expanding and all financial institutions are struggling to keep up with the technological (advances) and the advantages that come with being close to it, and innovations,” Clark said, adding that greater pooling of assets and the need to keep up with member funds’ assets and liabilities, investment strategies and the passing back of returns accordingly “needs an extremely good technological interface, and (funds) have to all the time be upgrading it to keep up with the market.”
Hints at investing locally
Before the government's announcement, industry sources speculated that the government would mandate further local investment among asset owners, something that governments and others across the world have started to mull — including in Canada and Australia.
In Australia, the country’s A$230 billion ($148.5 billion) Future Fund, Melbourne, will be required to invest more cash in the local economy, Bloomberg reported on Nov. 20. Under a new mandate, the sovereign wealth fund will be required to “consider Australia’s national priorities in its investment decisions,” such as increasing the supply of residential housing, supporting the energy transition and improving infrastructure, a statement by Treasurer Jim Chalmers and Finance Minister Katy Gallagher said.
Of course, the fund’s primary focus would still be to maximize returns, the government added. The wealth fund was set up in 2006 to "allow the Australian government to save today to meet the costs of tomorrow," according to its website. The fund operates independently from the government, and invests the assets of seven special purpose public asset funds — each with its own investment mandate.
And in March, 92 Canadian business leaders wrote to Canada’s minister of finance to bemoan the lack of Maple 8 investment in the domestic market.
The leaders cited figures showing that Canadian pension funds overall have reduced domestic listed equity holdings to less than 4% as of end-2023, from 28% of total assets at the end of 2000. Canada’s eight largest pension funds invest more in China (about $88 billion) than in Canadian listed and private equities (about $81 billion), the letter said.
In the U.K., rather than mandating any kind of local or U.K. investment, the government hinted at it — a good move, sources said.
“If you’re directing where to invest without a guarantee underpinning that should shortfalls exist … I can’t see why” plan executives would be prepared to be a fiduciary, Clark said. “You can hint (on where you want investment to go), but I think it’s incumbent upon government, if it wants to attract more investment into infrastructure, to make it attractive for domestic and global investors.”
And testament to that “wouldn’t be local governments investing, but attracting the Canadians, Australians or Americans to invest,” Clark added.
The government noted that if every local authority were to allocate 5% of assets to local investments, it would unlock £20 billion of cash injections into communities.
“We need that in the U.K.,” said Benoit Hudon, president and CEO of Mercer U.K. “If we want money for the NHS (National Health Service), for social housing, to fill the skills gap that exists in the U.K. ... If we want to attract investment in those areas, we need money, and one way to do it is to generate better returns in pension funds,” he said.
But there’s another source the government could have tapped on that front — the thousands of corporate DB plans still out there in the U.K. that are effectively forced into investing in government bonds, since the valuation of their liabilities is based on gilt yields.
“There’s no incentive in U.K. regulations to invest differently, other than in gilts. And that is something … in the regulations that needs to be changed, to give more flexibility to DB schemes, that may want to invest in different asset classes like infrastructure and growth assets and equities."
Investment strategies of DB schemes in the private sector "at the moment are suboptimal, and that’s driven by current regulations. If the government’s intent is to drive investment in the U.K., reforms probably need to be coupled with some kind of tax incentive for asset allocators to invest here,” Hudon said, citing Asia and the Middle East as being “quite attractive from an investment perspective” because of those other types of incentives.
U.K. lessons for others
But it’s not only the U.K. that can learn lessons from other markets — something sources were keen to point out.
“Auto enrollment is something the U.K. did really well, and I do think it’s worth highlighting,” Mercer’s Hudon said.
When consulting with the Canadian government on how to improve their own system, auto enrollment was highlighted for bringing more workers in the U.K. into the retirement system and accumulating savings.
“The coverage is better than what it would be in a country like Canada,” he said.
Government figures show that 88% of eligible U.K. employees were participating in a workplace retirement plan in 2022. In Canada, 37.5% of paid workers were covered by a registered retirement plan in 2022, according to the national statistical office, Statistics Canada.
The U.K.’s efforts to expand coverage to the gig economy, for example, is also a potential area for the government to look at. “That’s not to be covered in this round of reforms, but is something the government will have to think about in the current economic environment,” Hudon added.
