Turning the page (to a better future for the UK)

Investing in the UK – in this note we highlight some thought-provoking analysis from the team at Ondra. Their full report can be accessed here.
Policy choices – these include increasing contributions to DC schemes, focusing investment in the UK, making tax benefits contingent on home investment, and developing a Sovereign Wealth Fund.
A turning point – the UK has a large (£2.5tn) pool of pension assets. However, this is increasingly invested in low returning assets, or overseas, to the detriment of UK economic growth and prosperity. In our view, reversal of this trend is central to improving the performance of the UK economy, tax take, pensions, and equity market. 

The problem – although it should be obvious, it needs to be repeated. The policy and tax changes around Defined Benefit Pension schemes (DB) have been disastrous for companies, the economy, the taxpayer, the equity market, shareholders, and savers, and sub-optimal for pensioners. We outline the impact in brief below:

  • Over the past 15 years, UK-based businesses have injected c.£250bn to fill-in the ‘hole’ in pension schemes. This absorbed capital, reduced investment, impacted productivity and reduced shareholder returns.
  • The economy has been impacted by the dampening of growth aspirations of companies with pension deficits and the inevitable focus on short-term cash generation vs long-term investment.
  • The tax take has been impacted by c.£50bn given that pension contributions are tax deductible.
  • Pension funds were forced to become risk averse and reduced/exited equities, thus impacting growth assets and the UK equity market.
  • The drive towards fund buy-outs has resulted in further de-risking as schemes move to be ‘buy-out ready’.
  • Shareholders have had to forgo the benefits of growth and the dividends forgone.
  • Pensioners have had payments capped or reduced as schemes have had to move into the Pension Protection Fund (PPF). The value of pensions is generally reduced as many schemes’ cap increases, particularly if they have a deficit.
  • The surge into gilts ensured that interest rates were lower for longer, which impacted the income of those purchasing annuities and people with cash savings.


There were some that benefited from this period. For example, home-owners benefited from ultra-low interest rates and leverage was cheap and freely available for companies (particularly privately owned) and asset purchasers. All of this meant that asset prices were high but growth was low. This was based on a belief that interest rates would stay low forever, which has proven to be an incorrect assumption.

However, we are now at a turning point given that DB pensions are largely in surplus, with PwC estimating a current funding ratio of 121%. This gave a surplus of £240bn in March based on a buy-out value, with the total surplus some £150bn higher. Furthermore, the value of Defined Contribution (DC) schemes continues to grow, helped by auto-enrolment and increased contributions.

We have £2.5tn of pension fund assets in the UK, which is one of the largest in the world. The largest amount is in DB schemes (c.£1.5tn), with DC schemes having c.£0.6bn, and local government pension schemes (LGPS) on c.£0.4bn.

The biggest opportunity to improve UK growth is to ensure that DC schemes and LGPS are focused on growth assets and domestic investments given the longevity of their schemes. Inevitably DB schemes need to have greater matching of cash-generating assets to liabilities. Nonetheless, we believe there are several potential changes that could transform the level of investment in growth assets.


DB – run-run-run (for longer)

The impact of the funding issue for DB schemes has resulted in companies seeking to remove the schemes from their balance sheets in a buy-out as soon as they can. This is not surprising given the scale of pain (financial and time), and the desire to eliminate risk, as well as risk aversion from actuaries and trustees.

However, there is a lot to be said for continuing the schemes as it could provide better outcomes for the company, shareholders, the economy and pensioners. We believe there is a real opportunity to take a fundamentally different approach now that most schemes are in surplus. Furthermore, it does not require many years of compounding performance to make a material difference (particularly for larger schemes).

There are a number of potential opportunities/drivers. Many of these are captured in the DWP’s DB Scheme Consultation, which is part of the government’s desire to ‘overhaul the pensions landscape to provide better outcomes for savers, drive a more consolidated market, and enable pension funds to invest in a diverse portfolio.’ The consultation closed on 19 April and the government will now consider the submissions. We expect to hear more in the coming months, with the next Mansion House statement in July a likely format for active proposals.

The government is committed to reducing the tax on extracting surplus assets from 35% to 25%. However, we are concerned this is not a big enough incentive to continue a scheme, and believe more needs to be done to encourage company management and trustees.

  • Some of the surplus could be used to fund employer DC scheme contributions, as well as enhance DB pensions. This could reduce contributions from the company and the employee at the same time as stepping up overall contributions – a win all round.
  • The government could enable a proportion of the surplus to be apportioned to higher growth assets, and the company and pensioners could see benefits through greater access to the surplus (with sensible caveats applied).
  • The government could improve the attraction of one-off payments to members, which would increase the desire to run on a scheme.
  • The ability of company sponsors to benefit from the surplus would encourage schemes to run on. Guardrails could be established to ensure that the surplus could be returned over a period of time so that changing market conditions are taken into account.
  • There could be encouragement to invest in UK assets through tax credits.
  • Funds could be encouraged to become part of the PPF in order to build a fund of material scale. The PPF has assets of c.£33bn and a £12bn surplus. In its recent submission to the DWP’s consultation, the PPF highlighted that there are up to 2,3oo schemes with 960k members and assets of £130bn that do not have access to a commercial solution. The PPF estimated that it could allocate £10bn to UK growth supporting investments if it is enabled to be a consolidator.
  • The PPF’s exposure to public equity dropped from 5% to 3% in the year to March 2023, with net sales of £2bn. The PPF does not provide data on the holdings in the public equity portfolio nor its allocation to UK companies. Encouraging the PPF to increase investment in growth assets in the UK would have a positive impact on overall economic growth.
  • Reducing or eliminating the 10% haircut (ie having a 100% underpin) when entering the PPF would materially increase the attraction for funds to transfer in and enable the PPF to be a consolidator.

Ondra has proposed a tax on pension scheme buy-out surpluses. This may be a step too far for politicians, but greater work should be done to utilise the scale of funds productively and to provide an environment for schemes to run on. The reality currently is that there are far more schemes looking to do a buy-out than the capacity of the buy-out market.

The Mansion House Compact was the start of establishing a principal that UK pension assets have a responsibility to invest domestically for the benefit of all stakeholders. However, the scale is limited (at 5%) and the timing protracted
(to 2030).

Ondra sees the potential to increase investment in UK (public & private) assets by £300bn through linking pension tax privileges to a minimum of 20% investment in the UK. To put this in context, pensions currently have £90bn of investment in UK equities.

Changing views on DC schemes

The good news is that the introduction of auto-enrolment has resulted in a significant increase in the number of people contributing, rising from 18% of employees in 2012 to 51% in 2021 (with those on DB schemes steady on 28%).

However, the level of contributions is far too low to ensure a reasonable income in retirement and we are well behind international peers, as shown below.

Figure 1: Pension contributions

Source: Ondra, New Financial


Under auto-enrolment, a typical contribution in the UK is 8% (split 5% employee and 3% employer). This is well below other countries and the Pension Policy Institute’s guidance of 20%. Work undertaken by Aviva, the Living Wage Foundation and the Resolution Foundation views 16% as a level that can facilitate a socially-acceptable adequate standard of living (Living Pension Report). This is the level that will be reached in Australia in 2025 (12% employer and 4% voluntary employee contribution).

It is important to remember that DC pensions are in reality savings schemes. This means that growth of the schemes is as important as the level of contributions. The Nest performance data shows exactly how important growth in the fund is – its Lower Growth Fund lives up to its name, with an increase of just 7% over five years, which compares to an increase of 116% for the Sharia fund. The big difference is that the Sharia fund is fully invested in equities.

The other aspect to consider is where the funds are invested. AustralianSuper has a clear commitment to Australia, with 23% of its cA$315bn fund invested in Australian equities (c.10x overweight). This is part of its commitment to helping the domestic economy, companies and tax revenue. This makes sense given that the vast majority of contributors to the fund are Australians and will retire in Australia, which means that the performance of the economy and the funding of public services has a direct impact on their quality of life. This is Australia’s largest DC scheme with 3.3m members. Its annual report has a section on how much of the fund is invested in Australian companies (A$65bn at the time), as well as how it makes a positive contribution to members’ retirement and the Australian economy. This is supported by a recent report from KPMG, which demonstrates the positive impact on GDP, companies and jobs.

In comparison, Nest is the UK’s largest workplace pension scheme with £37bn of AuM and 12m contributors. In the Nest annual report, there is no ability to understand the level of investment in the UK or the underlying assets. There is also no commentary on the contribution to UK society or economy. The public companies it invests in are mostly overseas and megacap.

Nest receives £6.5bn in annual contributions. We assume c.5% (or c.£300m) goes into UK equities. If the level of contributions doubled (ie from 8% to 16%), and a similar proportion to AustralianSuper was invested in the UK, then the annual investment in UK equities would be £3bn per annum. Extrapolate this across the DC market (Nest has a c.5% share), and there would be considerable additional contributions to drive investment and growth. There should be a virtuous circle whereby the additional returns drive an increase in performance.

The Ondra report (see p13) advocates increasing employers’ contribution from 3% to 9% over a period of time. Although a material increase, this would still be below the 12% level set for Australia in 2025. Clearly this is an additional expense on businesses, so it would be sensible to grade the increases over time to make it manageable. What is not in doubt is that this level of shift would make a vast difference over time to the quality of life for pensioners and the performance of the domestic economy. Although there would be an additional cost for employers, there would be meaningful offsets in the longer term:

  • Increased investment in the UK economy should drive economic growth, which would help to absorb the cost.
  • The impact on public finances would be lower in the long-term, reducing the requirement to increase tax.
  • The additional cost could be eased by utilising surpluses from DB schemes.

We believe there also needs to be a greater cultural understanding of pensions, so that people can make better and more informed decisions. In general, the understanding of pensions in the UK is well behind other countries (eg the US or Australia). As shown above, the difference can be dramatic over time.

Sovereign Wealth Fund

This has been talked about for many years, but there has been limited will to seed a fund. However, Ondra has suggested using the realisation of the investment in NatWest to seed a UK SWF.

The government’s stake in NatWest is currently valued at c.£7bn. This could then be allocated across managers of small & midcap funds, and the government would then hold 2% of each company if spread across the whole of the small & midcap market, or higher for individual companies if actively managed. This level of investment in the UK economy would make a considerable difference at this scale. However, it could be considerably higher if other assets are injected into the SWF. It would also generate dividend income of c.£250m per annum, which could be reinvested in the market.

A SWF directed at UK small & midcap companies would be material in size (a large fund is typically c.£1bn) and able to support growth investment. It could also be a cornerstone investor in IPOs to kick-start the market. In addition, there would likely be additional investment (ie crowding in) as other funds recognised the potential to turbo-charge the market.

Using the NatWest funds to establish a SWF would initially be net neutral for government funding, but should generate a material return given the current valuation gap on UK small & midcap companies and through the ability to accelerate UK economic growth.

The Ondra report also suggests reinvesting 50% of North Sea windfall tax. This would have an impact on government borrowing in the short term, but the benefit of additional economic growth should significantly outweigh in the medium term.

An interesting comparison is with the French SWF – Bpifrance. Bpi has a remit to support public and private companies to help entrepreneurs and businesses thrive. It now has over €50bn of AuM and an equity portfolio of €17bn. This encompasses helping smaller companies grow and large cap investments in companies considered strategic for the national economy, and which can benefit from a stable long-term shareholder ownership.

Bpifrance and Caisse des Depots have combined to actively support IPOs in France with a budget of €800m, as discussed here. The benefits of this approach were demonstrated with the recent IPO of Planisware, where Caisse des Depots was a cornerstone investor.

Encourage home advantage

Ondra rightly points out the UK’s record in creating market-leading businesses with unicorn status (as well as many smaller businesses). The problem is that many of these are funded by overseas investors, who understandably then want them to grow and list in their own market (ie the US). This is supported by federal funding and encouraged by market scale, local expertise and breadth/depth of investor appetite in the US.

There is no point in bemoaning this, as it is a core reason for the ongoing success of the US economy and its ability to draw in talent. The solution is to provide encouragement to companies and entrepreneurs to establish their businesses
in the UK, and to scale them, fund them and IPO them at home. We believe
all parts of this process are fundamental to ensuring we retain the next generation of great companies.

Ondra recommends a range of incentives for both entrepreneurs and early investors in start-ups. Perhaps these should also be tied to having a listing in the UK rather than an overseas market. This stands to reason if these companies benefit from UK capital and UK tax incentives (eg R&D credits). Our current tax regime does not encourage founders to stay and grow their business in the UK – instead it seems fixated on avoiding ‘lost’ tax and in so doing, ensures that the investment and growth goes overseas – strangely this opportunity cost is left out of the tax calculations.