UK pensions investing in private markets may be right idea, wrong time: Peacock

Zawya

a day ago

(The views expressed here are those of the author, the former head of communications at the Bank of England.)
The UK government, searching for ways to jump-start the economy, has trumpeted a deal with pension funds to invest more in infrastructure, green energy and cutting-edge businesses. But this may be an example of the right idea at the wrong time.
Earlier this month, finance minister Rachel Reeves inked an agreement with 17 UK pension providers that she said would enable them to invest 10% of their portfolios in private markets, with half of that ringfenced for UK assets. That, she said, would unleash up to £50 billion of investment for UK business and infrastructure projects by 2030.
But getting to this figure requires some aggressive assumptions, even for a pensions industry that experts estimate holds nearly £3 trillion in assets. And, importantly, the pledge is voluntary, not binding.
That's for good reason, though, as pressing pension funds to invest in a certain way could cut across their obligation to act in the best interests of future pensioners.
Reeves has not ruled out mandating how funds should invest, although she has said does not believe it will be necessary. That has caused some alarm in the industry. The Association of British Insurers' statement in support of the accord made clear that the commitment was subject to the sector's fiduciary duty to its customers.
And even if we acknowledge that allowing – but not forcing – UK pensions to invest in UK private businesses has significant merit, given that the UK needs a boost and private markets are offering attractive returns, there is also the issue of timing.
The plan would likely have been easier to sell during the dozen years up to late 2021 when interest rates remained close to zero. Now a fund can get almost 5% on 10-year gilts, and many major equity markets are offering bumper returns. While pensions' return targets are typically higher than 5%, the need to 'stretch for yield' is no longer as acute.
Indeed, many pension funds today appear to be in decent shape. Data from the Pension Protection Fund show the aggregate funding ratio for UK defined benefit pension funds was around 85% a decade ago, compared with 125% now. The number of schemes in deficit has dwindled from nearly 5,000 to just 1,400.
DEFINED CONTRIBUTIONS
Most private sector pensions are now defined contribution schemes, which do not offer a guaranteed pay-out and instead depend on the size of the pot an employee builds up over their career and the fund's ability to invest to ensure that its assets match its liabilities.
This matching issue is one reason that regulators may be concerned about pensions investing in more hard-to-sell assets. Private markets are significantly more illiquid than publicly listed equities and bonds. The flipside of this, of course, is that privates tend to be less volatile during crises. But this illiquidity could mean that funds would be forced to sell more liquid assets in a panic, regardless of the quality of those easy-to-sell assets.
The chaos that engulfed pension funds after Liz Truss's ill-conceived 'mini budget' three years ago caused a scramble to sell assets remains fresh in the memory.
Additionally, privates are less well-regulated than publicly traded assets and typically more challenging to value because less information is easily available. This is especially the case when it comes to start-up companies, which could soar, but which more often will fizzle out.
ALTERNATIVE ROUTE
A safer route to raising UK productivity may be having the government borrow more to invest in infrastructure and green energy. Pensions can simply lap up that excess debt.
The demand appears to be there if this year's gilt sales are anything to go by. A raft of auctions has generally seen bids outstrip the amount of bonds on offer by roughly a factor of three.
In theory, the additional debt the government is taking on now would be offset in the future by higher growth. And a shift toward 'industrial policy' would be in line with what has been seen recently in China – particularly with green technologies like electric vehicles – and in the U.S.
Of course, this is assuming that the UK government will be able to invest wisely, including in emerging technologies.
Alternatively, the government could consider supporting more public-private partnerships, possibly underwriting a small proportion of a project's cost on a first-loss basis to leverage private sector involvement.
Overall, the most important thing is to spur the development of productive schemes that UK pensions – and others – can invest in. But pensions certainly should not invest just because ministers want them to.
(The views expressed here are those of Mike Peacock, the former head of communications at the Bank of England and a former senior editor at Reuters).
(Writing by Mike Peacock; Editing by Anna Szymanski and Toby Chopra)