Rachel Reeves’ Speech in the palace last November he was not ambitious, promising “the biggest pension reform in decades”, and two public consultations on what this means in practice end in a few days.
As part of her “invest, invest, invest” mantra to boost growth, the Chancellor’s Autumn Budget announced £100bn of capital spending over the next five years. To raise this without spooking the market horses, Reeves wants to merge pension funds into “megafunds”, which then invest more in UK “private assets” – venture capital and infrastructure.
This “shrinkage” applies to both the £400bn defined benefit scheme for local government staff in England and Wales (the £60bn local government scheme in Scotland is not included) and defined contribution (DC) workplace pensions for employees in the private sector. The government also wants DC pension savers hold more in UK shares.
Political rhetoric aside, these “reforms” seem to be based on an incomplete and flawed analysis.
For DC workplace pension funds, the government wants a minimum size of £25bn, and preferably up to £50bn, with fewer “default” investment options. It is significant that the changes will not occur before 2030, after the date of the next general election.
The UK currently has around 30 “master trusts” authorized by the pensions regulator and a further 30 “contract-based” providers, with total assets of £480bn.
DC pensions certainly need a minimum asset size to spread fixed costs and encourage good governance, but the government’s analysis of why the threshold should be as high as £25bn is weak, and its comments on Canadian and Australian pensions are selective or irrelevant.
For example, all the Canadian “Maple 8” pensions that Reeves loves so much are either public sector defined benefit plans – including Ontario’s three plans for teachers, medical staff and local government staff – or they fund Canadian government pensions, so say we have nothing on UK DC pensions.
And yes, Australian DC “super funds” are larger in absolute terms than UK DC pensions, but they run much longer and have much higher annual contributions (the UK government, meanwhile, is postponement of review in increasing the minimum amounts of automatic enrollment). But Australia is also much less concentrated than the UK, with the top 10 largest schemes holding a much smaller proportion of total assets than the UK.
What exactly do DC savers get out of investing in the UK, apart from the patriotic glow, like buying war bonds?
The Government Actuary’s Department analysis published in support of the Palace Speech is not encouraging. It concludes that the likely risk-adjusted returns for DC savers if they switch from holding international stocks — particularly US stocks — to UK stocks and private equity are about the same. Any differences over 30 years of regular savings are lost by rounding.
Since the probable returns are identical, DC savers should make their investment decisions based on the second order of maximizing international diversification and minimizing costs.
UK stocks represent 4 percent of the MSCI world index – US stocks, dominated by big tech companies, make up 70 percent. But the UK’s equity allocation to DC pensions is already 8 per cent, double the “neutral” weighting.
There are good reasons why British investors are overweight in the UK – lower management costs and expenses, no need to hedge against the pound, and many UK companies operate overseas, providing some international diversification anyway.
The chancellor can always tip the scales and subsidize UK stocks by restoring the dividend tax credit that was scrapped in 1997 by the previous Labor chancellor, Gordon Brown. The main reason Australian savers hold Australian shares appears to be the Australian dividend tax credit. Doing so in the UK would surely be expensive, and surely it is better to give tax relief directly to companies that invest in their business?
In terms of minimizing management costs, fees on UK private assets are much higher than on public, passive equity trackers. Adding insult to injury, performance fees, which are paid on top of annual fees, are excluded from the 0.75 percent auto-enrollment fee cap.
Meanwhile, the new pensions minister, Emma Reynolds, has also slammed us warning that “the government could force pension funds to invest more in British property”. However, it does not explain how this might work in practice, given the statutory and common law fiduciary duties of pension trustees to act in the “best interests” of their members.
She hinted that the government could cut tax breaks on foreign investment, which would certainly undermine confidence in pension savings, which are fragile even at the best of times.
Over the years, various foreign governments have tried to dictate how pensions should be invested, but none have succeeded. Let’s hope the Labor government quietly drops the idea of ”forcing” UK pension funds to invest in the UK.
John Ralfe is an independent pensions adviser. X: @johnralfe1
