Should pension funds invest in UK growth?

Tgloomy outlook for the economy coupled with the burden of an ageing population appears to be increasing the frequency of calls for the UK’s pension schemes to step up and improve the country’s growth prospects.

In 2015 George Osborne asked LGPS funds to pool to bolster investment in infrastructure; last year the then-Prime Minister and Chancellor Boris Johnson and Rishi Sunak called for an investment ‘big bang’; and this March Baroness Ross Altmann called on the current Chancellor, Jeremy Hunt, to require pension schemes to invest a minimum in UK growth assets

In recent months, there seems to have been a shift in the political argument about pension scheme investing.

Matt Gibson, head of investment research at LCP, says: “Individuals are given a tax break on their pension investment so they can accumulate enough not to be a burden on the state in later life.”

But now politicians appear to be arguing that the state should see some advantages too. Gibson continues: “There are signs of a growing pressure on pension schemes to invest in the UK in order to justify the tax break.”

These calls for UK pension schemes to invest in the country’s growth assets represent, at best, confused thinking –and at worst a lack of understanding of the regulatory and market constraints which shape schemes’ investment strategies.

Joe Dabrowski, deputy director of policy at the PLSA, says: “The fundamental challenge is finding the sweet spot which matches pension schemes’ needs with the government’s requirement for investment into certain types of assets.”

Pension schemes must ensure any potential investment meets a trustee’s fiduciary duty, provides value for money, and gives the best possible outcome for members.

Dabrowski comments: “Recent calls for pension schemes to provide more capital have lumped all schemes into the same bucket.”

WHICH SCHEMES SHOULD INVEST?

Adam Saron, founder of Clara-Pensions, agrees: “It is very unclear which pension assets are supposed to invest in UK growth. Is it defined benefit or defined contribution schemes?”

The reality is the UK’s funded occupational pension scheme landscape is fragmented. Each of the three main categories - closed defined benefit (DB) pension schemes, open DB (including LGPS funds), and defined contribution (DC) schemes typically used for automatic enrolment - has a different approach to investment.

Deciding which pension asset base should be investing in UK growth assets is important because it will affect when the government wants this investment to happen.

Saron says: “If you want investment big bang now then you have to go after DB schemes because they are the largest asset base.”

But it is far from certain DB schemes will want to invest. Dabrowski points out that: “The ability of a closed DB fund to invest in growth assets will depend on how close it is to buyout.”

A scheme less than 10 years away from transferring its assets to an insurance company is unlikely to want to add additional illiquid assets, such as infrastructure, to its portfolio.

“A scheme would only want to add this type of assets if they were to generate returns as well as be able to transfer them to an insurance company,” says Dabrowski.

The number of closed DB pension schemes which want to add more alternatives to their portfolios has recently decreased. Katie Sims, head of alternatives at WTW, says: “Thanks to the disastrous mini-Budget of last year, many pension schemes find themselves with a much shorter time horizon to buyout than they thought they had. That is not conducive to them increasing allocation to illiquid investments.

“In addition, many schemes are now over-allocated to alternative investments because the value of both assets and liabilities have fallen and schemes had to sell liquid assets to maintain collateral positions,” adds Sims.

Not every closed DB scheme, however, will be thinking about buyout. Dabrowski says: “Some schemes are aiming for