Hot on the heels of Ian Duncan Smith’s suggestion that pension schemes should invest in unicorn technology companies came last week’s challenge from the Prime Minister and the Chancellor for institutional investors to participate in an investment big bang.
While the pensions industry made polite noises in response to this letter, it wasn’t hard to discern the frustration with the government’s latest wheeze to use pension schemes as its new piggy bank.
The letter says: “For example, over eighty per cent of UK defined contribution pension funds’ investments are in mostly listed securities, which represent only twenty percent of the UK’s assets.”
In other words, the government would like pension schemes to provide capital to those UK businesses which are not listed on an exchange. That would mean allocating assets to private equity and infrastructure funds.
It’s not clear why private equity companies would need a significant cash injection from UK pension schemes. These strategies are popular with other investors and often suffer from a dearth of investable companies.
Both private equity and infrastructure funds have high fees, sometimes including significant performance charges, while auto-enrolled pension schemes have an investment management charge-cap of 0.75%.
The government has proposed loosening the charge cap but this will not necessarily encourage these pension schemes to invest in these more costly funds.
Some pension schemes compete for market share on price. If investing in private equity and infrastructure pushes up the overall cost, it will deter schemes from allocating a significant proportion of their portfolio to these funds.
And even if a pension scheme were to decide to allocate to either private equity or infrastructure, it would not only be invested in the UK.
The purpose of a pension scheme is to provide the best possible retirement income for its members. This fiduciary duty is the guiding principle of its investment policy.
Not only is it important to ensure a pension scheme’s portfolio will produce returns to grow its members’ investments but also this should be done without excessive risk.
One of the ways pension schemes manage risk is to diversify their portfolio around the world to harness the growth potential of the global economy. In other words, they don’t put all their eggs in one basket.
Supply not demand
The letter also makes clear the government sees pension schemes as their new source of capital to fund the infrastructure projects needed to convince their Red Wall voters it can deliver on its promises of levelling up.
“It’s time we recognised the quality that other countries see in the UK, and back ourselves by investing more money into the companies and infrastructure that will drive growth and prosperity across our country,” says the letter.
This is not the first time the government has seen pension funds as a way to fund infrastructure projects.
In 2015, George Osborne announced the pooling of the local government pension scheme’s 89 separate funds in England and Wales to add efficiency and make infrastructure investing easier.
That pooling has now been completed with the 89 funds grouped into eight pools. This scale has enabled pools to negotiate better rates with investment managers and made them more professional.
But there has not been a material improvement in infrastructure investing. That’s because it is not a lack of capital which is holding this back.
Pension schemes around the world are thirsty for these projects – they have just the right kind of long-term income streams which match their liabilities. This is why, as the letter acknowledges, pension schemes from Australia and Canada, have invested in the UK.
The hold-up in infrastructure investment is lack of supply. These are highly complex undertakings which take years to implement and are frequently held up by planning headaches.
It is also a question of risk management. While pension schemes like infrastructure as an investment, they want projects which have a guaranteed income stream.
They will not fund speculative developments. Often schemes want governments to take the initial risks and become involved later on. And that’s because a pension scheme’s primary purpose is its fiduciary duty to its members not a government’s economic agenda.