Pensions are the UK’s second biggest asset. They account for 35% of household wealth, only slightly behind property on 40%, and are vital for our standard of living in retirement and the health of our economy in the long run. They are also a key cause of the UK’s weak economic performance and lacklustre productivity growth over the last 25 years. Why? Well, it’s simple. Over the last 25 years, pensions have sold over £1tn of UK equities. This has deprived the economy of vital fuel for its growth companies and cost the government some £50bn in tax revenue. Companies, meanwhile, have had to inject over £250bn into their own pension schemes.
Surely the pensioners have benefited from this cash tsunami? Sadly not. UK pension funds have materially underperformed global peers and pensioners have missed out on potentially higher incomes from fund exposure to growth assets.
The good news is that the future is more promising. Defined Benefit (DB) pensions are now in a healthy surplus, which gives an opportunity to reassess risk and invest in more productive assets. Although DB is the largest part of the pensions market, the reality is that many schemes are in run-off and so the scope to invest more productively is limited. The bigger opportunity is in Defined Contribution (DC) schemes, which will grow assets by over £50bn per annum. The Mansion House Accord will push DC schemes to invest in growth assets (target 10% of AuM) and in the UK (5% of AuM). However, policymakers should be more ambitious.
Investing in UK-listed companies would drive the economy, increase tax revenue, and improve returns for savers—a real win-win-win. If just 10% of the annual increase in contributions headed into UK equities, it would transform the long-term prospects for UK capital markets and ensure that the UK was the listing venue of choice for growth companies. The government’s recent Pension Review stated that DC funds should provide details of their asset allocation by early 2026, which will shine a light on just how low their UK investments are.
What can companies do to make this happen? The answer is a lot. We need to change the focus of advisors, consultants, and trustees towards value for money over cost to enable increased investment in growth assets. We have to grow risk appetites and make sure employees are properly informed when they choose a pension, starting with basics like where their pension is invested and the importance of compounding returns Over the longer term, the UK has to increase contributions—the current minimum of 8% is nowhere near enough. Over time, it should rise to over 15%, with the increase shared by employers and employees. This should not be politically or commercially sensitive given that it can be embedded over time and will meaningfully add to long-term prosperity. Consider, for instance, the experience of Australia—which has been steadily increasing its rate of employer contribution (now 12%) over time—to see how getting the pension model right produces benefits for the domestic economy and equity markets.
The UK’s largest workplace pension scheme is Nest, which looks after 13m UK citizens and manages c.£50bn of funds with growth in excess of £10bn per annum. If you choose their Higher Risk Fund, the 10 largest companies in the portfolio are all US-based. And the top six are all US tech firms. Understandably, the performance has been good—at some 9% compounded. But it has involved heavy concentration risk and a significant US dollar weighting. That has been good in the past but will it be in future? The bursting of the dot-com bubble in 2000 offers a cautionary tale. What is more, do people who save through this fund realise that just 3.6% of their money is invested in UK businesses? I suspect not.
The Nest Sharia fund has benefited from a higher allocation to equities, which has helped performance (14% CAGR). However, this fund is heavily overweight the US too and has just 1.8% invested in the UK—and only in five large companies (Astra, Glaxo, RELX, Rio Tinto, and RB). The UK is apparently not very ethical either, as just two companies make it into the Nest Ethical Fund (Astra and LSEG). Then look at their Lower Growth Fund, which does just what it says on the tin. It has delivered a 1% CAGR over the last decade, which is a disastrous performance that does not even preserve real capital value.
Given that Nest has a large number of younger savers, and the average amount in a Nest fund is just £4k, increasing contributions and improving investment performance are absolutely essential to deliver a reasonable pension in retirement.
This is not to decry Nest, which has been a great success story and is a vital part of the DC pensions market. Nest has also been stepping up its investment in UK assets, although thus far this is targeted at private markets. It is more to recognise that we have established a pensions market that is largely divorced from its home market and where the risk warnings are the wrong way round—the bigger risk is not having enough risk in your fund.
We should also recognise that pensions receive material tax benefits and that the recipients have a clear vested interest in an economy that can afford essential public services. It is the epitome of selfish investment to only focus on returns to the individual and not the wider interest of the country.
It is not too late to make the necessary changes to ensure that we have a pensions market that delivers higher savings income, a healthy capital market, and stronger economic growth.
Charles Hall,
Head of Research
