Plans to tap pensions to fund Britain’s post-Covid recovery arrived via a Number 10 press release as a golden opportunity for the country: ‘Prime Minister and Chancellor challenge UK investors to create an ‘Investment Big Bang’ in Britain’. Evoking the deregulation of the 1980s is a bold choice – the modernisation of the City of London undoubtedly spurred activity, but also removed safety walls between investment banking and deposit taking that ultimately would lead to the 2008 Global Financial Crisis. Likewise the involvement of governments with five year life spans in retail investors’ 30 plus year pension plans necessarily poses certain risks.
UK institutional investors
UK institutional investors are under-represented in owning non-listed UK assets, according to the government’s figures; over 80% of UK defined contribution pension funds’ investments are in listed securities that represent only 20% of the UK’s assets. Arguing this is a missed opportunity, the government is pushing to make it easier for DC pension funds to invest in long-term illiquid UK assets (it’s already possible for defined benefit schemes). These plans, in motion since 2019, are now yoked to post-Brexit, post-Covid, ‘Build Back Better’ jingoism. Including environmentally-conscious investments also complements the UK hosting of the 26th UN Climate Change Conference of the Parties (COP26) this Autumn. “We want to see UK pension savers benefitting from the fruits of UK ingenuity and enterprise... secure higher returns and better retirements,” Chancellor Rishi Sunak and the Prime Minister said in a joint open letter to the pension industry in August.
How fund managers viewed it
Fund management has largely embraced the move. Flag bearers in the government press release include Anne Richards, CEO of Fidelity International, an asset manager and DC pension provider – “we see the benefits of making long term, less liquid assets available [and] believe our customers will welcome more choice”; Andy Briggs, Group CEO of legacy pension scheme the Phoenix Group is “supportive of directing substantial long-term investment into infrastructure and housing, as well as providing early stage capital for [UK] companies”; and Chris Cummings, CEO of the Investment Association, heralded it as “a positive move that will benefit pension savers, while boosting the supply of much needed productive finance for the UK economy”, adding “certain retail investors should also be allowed to access the same opportunities”.
Amid this potential for sunlit uplands Britain has long been promised and is yet to visit, are, however, risks. While overall the fund managers are keen, the actuaries are cautious. As Steve Webb, partner at actuarial firm LCP and a former Pensions Minister (who was not on the government’s press release) points out, if what is being proposed was that good, pension funds would already be doing it; if there are good reasons they aren’t they “almost certainly should not change their investment strategy simply because of ‘exhortations’ from the government”.
Pension funds will, for example, want completed infrastructure projects that have passed all planning processes and legal objections (for reasons of reliability and timing of returns) over early stage projects (which may never get off the ground) of the sort the government wishes them to fund. Many occupational pension funds are maturing and moving to lower risk investments; where infrastructure offers a relatively low risk stream of index-linked returns, schemes are already invested, Webb says.
For pension funds aiming for a buyout soon, infrastructure assets maybe an undesirable selling point to be offloaded at a loss unless there is “a method of selling it on”, Webb adds. The Pensions Regulator is already concerned about schemes invested “too much” in illiquid assets, so any policy from central government needs to be consistent with TPR.
Smaller pension schemes may not have the necessary in-house specialist resources for the specialist job of appraising infrastructure investments: “It can be bought in, but this increases the cost of including this asset class”, Webbs points out.
Perhaps most important is the risk of political boredom with long term projects alongside much shorter stints in power. “The great unknown is government policy,” says Tom Selby, head of retirement policy at pension and fund management firm AJ Bell, “one administration may prioritise investing in roads and rail, another might decide this is the wrong approach and deploy the considerable resources of the state elsewhere”.
Another problem of political pace versus real word timing is regulation. The Financial Conduct Authority has consulted on but is yet to confirm rules for new Long Term Asset Funds (LTAFs) to better facilitate DC pension schemes and ordinary investors investing in less liquid assets like venture capital, private equity, private debt, real estate and infrastructure. It is a considerable shift.
Law firm Fieldfisher calls LTAFs “an intriguing proposition” involving a number of new “convergences”:
- retail investors with asset classes hitherto deemed by the FCA unsuitable for them
- illiquid investing in an open-ended fund; and
- regulated funds and liquidity management tools historically available only to their unregulated counterparts.
Cummings, CEO of the Investment Association, which pioneered the proposals for the LTAFs, admits they “require a new partnership” between regulators and industry to ensure “transparent, well governed funds that return good value for money”.
Caps on fees
Hargreaves Lansdown is, however, keen for a relaxation of “barriers” like the current “intense focus on costs almost to the exclusion of all other measures of value in workplace pensions”.
The Department for Work and Pensions is pushing for “flexibilities” in the cap on fees DC pension schemes can charge to allow investment in more expensive private equity ventures.
Policy support to guard against wide scale losses for funds or investors, however, is yet unclear. Scheme trustees have a duty to consider risk appetite, cost and, increasingly, impact on the environment – “nothing the government has said should materially change that focus”, Selby says, adding “just because the PM and Chancellor click their fingers doesn’t mean pension investors will flock to illiquid UK investments in their droves”.
As asset classes, actuaries Hymans Robertson like infrastructure equity and debt, among other higher-risk listed and private markets equity and higher yielding debt, particularly for income generation. “Infrastructure debt can enhance outcomes versus traditional debt such as government bonds and investment grade credit,” says Callum Stewart, head of DC investment at the firm. Given more limited adoption, there is an opportunity for DC schemes to include infrastructure in glide paths for members and improve outcomes, he adds.
But Stewart is seeing, and expects to continue to see, a focus on global infrastructure investment, not necessarily UK, because of the better risk and return credentials of a globally-diversified portfolio. “The latest policy intention is meaningful, though less from the perspective of creating new and attractive investment opportunities and more for shining the light on an asset class,” Stewart says.
Sitting at arm's length from the Treasury, the National Infrastructure Bank is there in part to help mitigate risk, and drive investments towards what the government believes are ‘high value’ projects. This should, in theory, help ensure a more coordinated approach towards assessing the merits of individual projects and deciding what kind of financing, if any, says Selby, so decisions are made with a degree of independence, rather than being influenced by politicians whose motivations might be shorter-term.
Without such a bank in place, it would almost certainly be harder for those proposing infrastructure projects to secure the finance they need, and to manage £10bn of guarantees provided by the state to boost infrastructure spending, Selby points out. But a National Infrastructure Bank “doesn’t guarantee infrastructure projects will be successful or deliver returns to investors,” Selby warns, “you can never be 100% sure the Prime Minister won’t wake up one morning and decide he wants to build a big bridge somewhere”.
Climate considerations and their interplay with long-term infrastructure and other projects are another risk point for pension investors, to no small extent at the mercy of the capriciousness of those in charge on the day. “There is a significant risk of policy change in future impacting infrastructure plans, and investment outcomes for pension schemes,” says Stewart, head of DC investment, Hymans Robertson. For example, a future government could roll back the intensity of plans to deliver a greener economy in future, leading to lower demand for infrastructure assets and potential price impacts for existing investors. “This is why a geographically diversified approach is one we support, rather than to focus solely on a specific region such as the UK,” Stewart adds. Climate risk should be a central consideration in any infrastructure investment in 2021 and beyond, echoes Selby: “If a project doesn’t put the environment at its heart, then as well as putting the planet – and future generations – in danger, it will also be open to future sanctions from governments.”
Ultimately, the job of pension schemes is to invest in a way that maximises returns for their members, not in the way the Prime Minister tells them to. Institutional investors need to prioritise diversification when choosing how to put members’ money to work, in terms of the type of company they invest in and the country in which it resides. There will be keen eyes trained on the detail which is due to be released by the government in the run up to the Global Investment Summit in October. As Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, points out, “the key will be to consider investors’ particular requirements and perspectives, ensure value, and create well governed products which deliver good outcomes”.