Ministers urged to beware unwise interventions in domestic pension fund investment drive

The UK Government wants to see UK pension schemes investing more in the UK economy, particularly in areas such as infrastructure, hi-tech businesses and start-ups.

Frustrated by a perceived low level of such investment, and the fact that money for such investments sometimes comes from overseas pension funds, the Government has concluded that it may be necessary either to force schemes to invest in particular ways, or to create new incentives to change investment patterns using billions of pounds of public money.

A new report, ‘UK Pension Schemes and Productive Finance – a framework for effective intervention’, produced jointly by economics consultancy Frontier Economics and pensions consultants LCP, finds that:

• Big differences in investment strategies between UK and other countries’ pension schemes, for example, Australia, are driven more by the much greater scale of these schemes compared with the UK, rather than by a general unwillingness by UK schemes to invest locally. See ‘Notes to Editors’ for an example.
• As UK schemes grow, they will, in any case, tend to diversify, investing more in the sort of assets that the Government wishes to promote, without needing to be forced to do so. Some larger UK schemes already have significant allocations to private markets and infrastructure, and more are set to follow as they grow.
• Just because pension schemes in other countries allocate a certain percentage to domestic ‘productive’ assets, it does not follow that this is the right answer for UK schemes. Instead, policy should identify ‘market failures’, i.e. those markets where the socially optimal level of investment is not delivered. 

Before intervening, in line with best practice, the government should identify what market failures it is trying to address. There might be a case for supporting investments that generate an environmental benefit, for example. It could be that investors struggle to assess risks and returns associated with some types of investment, such as long-term infrastructure projects or early-stage start-ups. Or perhaps ‘coordination failures’ will lead pension schemes to be wary of being the first to invest in higher cost but potentially higher return investments (such as private markets) for fear that they will stand out from the pack and lose business on price grounds. 

In each of these cases, there might be a case for government intervention. But even then, one would need to be confident that the Government has the appropriate capacity and information with which to make the assessment.  

The report then evaluates a wide range of existing government interventions in the pensions market under the ‘productive finance’ banner. 

Measures to drive up scale are likely to reduce barriers to investing in private markets and infrastructure, though much of the scale-up is happening already. The creation of ‘Long-Term Asset Funds’ (LTAFs) also has the potential to reduce barriers to investment in more illiquid assets by DC pension schemes. The report also backs the proposed freedom for pension providers to move poorly invested or under-performing ‘Group Personal Pension’ policies into more modern and productive investments. 

The case for giving schemes crude ‘value for money ratings’ in one of four brackets is less clear, and there is potential for this to lead to ‘herding’ behaviour as schemes are reluctant to step away from the pack – thereby reinforcing, rather than solving, a co-ordination market failure. 

The authors argue that the billions of pounds being co-invested via organisations such as the British Business Bank, the National Wealth Fund, and a plethora of other initiatives need to be rigorously tested. This will allow greater understanding of what market problem they are trying to solve and how far they may end up subsidising things which would have happened in any case – so-called ‘deadweight’ costs. 

Finally, the authors do not support the Government's power to take in the Pension Schemes Bill to potentially ‘mandate’ DC pension schemes to invest in private markets if voluntary commitments are not met by 2030. The paper argues that there is no clear case either for the Government to override the judgments of trustees acting in their members’ interest, nor for setting arbitrary top-down targets for total levels of ‘productive’ investment, which may be a very blunt and potentially ineffective policy instrument.