The public don’t generally like to think of their pension as risky, so it’s always a surprise when a politician argues that the issue with management of pension funds is that there isn’t enough risk-taking. But this is the view of UK Chancellor Jeremy Hunt, who argued recently that this is one of the ways to unlock investment in potential ‘high growth UK businesses’.
This week’s New Economy Brief looks at the debate over pension investments, including the growth of overseas ownership of UK businesses and infrastructure, and alternatives to the drive to leverage more private investment.
Pension funds aren’t investing in the UK. UK pension schemes are some of the biggest sources of capital for British companies, but according to the FT funds have been moving away from investing in the UK stock market, and more UK firms are listing overseas. Prominent business figures such as Nicholas Lyons, Lord Mayor of the City of London, have urged Chancellor Jeremy Hunt to compel more capital from UK pension funds into growing domestic companies and infrastructure.
- Who owns our companies? If UK pension funds don’t own UK shares, then who does? Pension fund demand for UK equities has fallen by £400bn since 1997. A report published in 2022 from the TUC, Common Wealth and the High Pay Centre finds that the proportion of UK shares held directly by UK pension funds decreased from almost 1 in 3 in 1990 to less than 1 in 25 in 2018. Most UK shares are now held by overseas investors, with the proportion rising from 12% to 55% during the same period. When accounting for direct and indirect ownership through pooled funds, UK pension funds own less than 6% of UK shares.
Chancellor urges pensions to make ‘riskier’ investments. Pensions funds have been making less ‘risky’ investments since the shift from defined-benefit to defined-contribution schemes, meaning more money has shifted from company equities and into government bonds. The government is due to publish new measures in the Autumn Statement to “unlock productive investment” from defined-contribution pension funds to enable more financing for high-growth companies and make the London Stock Exchange a more attractive place to list businesses. This could include pooling of Britain's ~28,000 fragmented defined-contribution schemes so they are consolidated in larger funds and ‘mandating’ pension funds to make certain investments.
- Looking to Canada and Australia? During a visit to Washington, Chancellor Hunt gave a speech noting that Australia and Canada have managed to increase their returns by consolidating their pension fund industry, which makes it simpler for them to invest in unlisted companies with higher growth potential. According to the OECD, the percentage of UK pension fund assets invested in equities dropped from 55.7% in 2001 to 26.4% in 2021. In comparison, Canadian funds had 40.6% and Australian schemes had 47% of their assets invested in equities.
- Crowding-in opportunities with carrots, not sticks. However, the FT’s Helen Thomas argues that “political edicts on investment strategy are not the right way to emulate the country’s success”, as pension funds in Australia were attracted by opportunities to invest in projects with high returns, rather than compelled. She suggests that the government is not offering enough opportunities in clean energy, housing, or transport infrastructure, quoting former regulator and professional pension trustee Andrew Warwick-Thompson: “It is not pension regime reform that is needed to increase investment in UK assets… but coherent, stable and sustainable economic and industrial policies to make the UK fundamentally more attractive to investors.”
- Risky business? Encouraging risks with pensions isn’t necessarily something you would imagine a UK Chancellor doing, especially a few months out from the big LDI pensions scare (ironically, caused by pension funds being overexposed to falls in the value of ‘safe’ government bonds as rates rose). Arguably the current system already involves too much risk for savers. The IFS last week published a report setting out the case for a new review of the pension system, arguing that the move to defined-contribution pensions results in “individuals bearing risks that are difficult to manage well”.
But is private investment necessarily the solution? British companies and infrastructure certainly need more investment, and both major parties have suggested mobilising private capital from pension funds as a way to revitalise the country’s infrastructure and grow the economy. However, Common Wealth’s Mat Lawrence argues that mobilising private capital can lock in extractive behaviours as investors seek ever higher returns, which could encourage profiteering from UK infrastructure and the green economy.
- De-risking private investment is not risk-free for the government. Private financing of infrastructure projects can be more expensive than government funding, exactly because private investors not only expect a steady flow of income in form of dividends but also want to minimise any risk to themselves. As economist Daniela Gabor has observed, attracting investment is increasingly accomplished through ‘de-risking’, where the state takes on the risks to ensure higher returns to private investors. In a piece for the Guardian, Professor Brett Christophers argues that the influence of asset management firms is inextricably linked to the ‘de-risking’ agenda (in which he includes the US Inflation Reduction Act). In a separate piece for the FT, Christophers explains the risks of relying on private pension funds to invest in public infrastructure.
- Look at the experience of developing countries. The down-sides of de-risking private capital to fill infrastructure ‘financing gaps’ have been thoroughly demonstrated by the World Bank’s programme to leverage investment for developing countries. Packaging infrastructure projects in ways to interest risk-averse institutional investors, such as pensions funds, require transferring risks onto the public sector, which has shown to bring excessive costs to taxpayers and exacerbate financial instability. A report by Eurodad’s María José Romero Duarte found that the World Bank's strategy of encouraging private investment in infrastructure projects goes against the historical experience of successful developed and developing countries, as well as the current practice in emerging markets, where infrastructure is mostly financed by the public sector.
Neglecting the role of public finance. State-backed investment banks are one route to providing finance where private banks may be reluctant to do so – in disadvantaged regions, new technologies or in sectors where returns are either too low or too risky.
- Patient capital and innovation. National investment banks are particularly valuable for providing 'patient' capital: long-term finance that is beyond the time horizon of most commercial banking but which is essential for innovation and strategic economic development. Economist Mariana Mazzucato explains why patient capital delivered through state-funded investment or development banks allows investors to take more risk (necessary for green innovation) as they are not required to pay dividends to private stakeholders, can meet more ‘public good’ objectives, and “can set conditions for access to their capital in an effort to maximise economic or social value to their home country.”
- National investment banks. The UK is unique among major advanced economies in not having a national investment bank. Advocates argue that such a bank would increase investment in innovation and support major mission-focused industrial transformations, such as building a green economy. UCL's Institute for Innovation and Public Purpose has examined the role which publicly-owned investment banks have played in a variety of countries to provide patient finance for innovation and business development, and proposed the creation of a UK National Investment Bank. The centre-right think tank Onward has also called for the establishment of a national investment bank, arguing that this could unlock £16 billion in capital for investment in small and medium sized businesses, municipal infrastructure and project finance to level up lagging regions. The Scottish Government established the Scottish National Investment Bank in 2020.
- Improving the UK Infrastructure Bank (UKIB). The UKIB is an Arm’s Length Body of HM Treasury, but is on track to deliver “barely a fifth of the financial support the European Investment Bank provided before Brexit” and is set to miss its annual investment target according to a recent report by the OBR. The UCL Institute for Innovation and Public Policy’s Thomas Marois analysed how the UKIB compares with other national infrastructure banks in Germany and Canada. The author notes the “remarkably little” investment given to the bank by HMT (£1.5bn annually) and a “fraught public-private partnership strategy that often costs taxpayers more while delivering less.” He concludes that the new bank is “anchored to past ‘market-failure’ approaches rather than a future where public banks, public purpose, and citizen engagement provide credible and innovative solutions to green and just transitions for people and planet.”
- More resources. Read our resource bank page for more on public finance institutions that can support economic development and another on how to rethink finance for business investment.