A seminal moment – The Mansion House Speech and the interim report of the government’s pension review demonstrate a clear shift in approach to growth and risk.
Accelerating growth – This is essential given the torpid performance in the UK since the global financial crisis (GFC).
A new approach – We see a fundamental shift as evidenced by the speeches, letters, and reports. There is considerable detail in the issued documents (much of which has not been reported in the press). The what-if analysis looks at increasing domestic allocation by 5-10%, resulting in an additional investment of £40-80bn in 2030.
The necessity for change
The UK has been locked in a low-growth environment since the GFC, with a paltry 1.1% annual GDP growth compared to 2% in the US. There are many reasons for this (reducing bank balance sheets, austerity, pension de-risking, ultra-low interest rates, Brexit, political instability, Covid, restrictive planning regime, etc.), but the impact is clear. For example, we now have:
- Rising government expenditure and deficit;
- Low and flat-lining productivity;
- Underperforming and challenged capital markets;
- Insufficient housing stock; and
- Infrastructure projects over-budget and over-time
The good news is that the UK has the tools and resources to address the challenges and the clear potential to accelerate economic growth. Recent performance has given a feeling of a doom loop, whereby any progress is stymied by either internal intransigence or external events. However, the UK has major strategic advantages, including:
- Location, legal system, and language;
- Deep and innovative capital markets;
- Innovation and design capabilities;
- Global connectivity; and
- Leading roles in turbo-growth sectors – e.g., AI, fintech, creative industries, and medical research.
With the right environment and government initiatives, the UK can return to being a higher growth, productive economy. This is why the recent initiatives are so important and could transform the UK over time.
Mansion House Speech (MHS)
The key announcement were:
- Rebalancing the regulatory system to drive economic growth and competitiveness;
- Pension consolidation to create megafunds and increase investment;
- Cornerstone investors to back the British Growth Partnership (BGP);
- Financial Services Growth and Competitiveness Strategy; and
- Introduction of PISCES.
Regulation – The Chancellor has written letters to the FCA, PRC, FPC, and PSR (click links to see letters) to ensure a greater focus on growth. We have seen suggestions that this is inconsequential – we totally disagree. Messages from the government demonstrate its priorities and clear direction. We have already seen material change at the FCA since the secondary growth objective was introduced in 2023.
Pension consolidation – This relates to both defined contribution (DC) schemes and local government pension schemes (LGPS), which control assets of c.£600bn and £392bn, respectively. The intention is to mirror the pensions landscape in Australia and Canada, to deliver better value and release c.£80bn to invest in growing business and infrastructure. In this article, Paul Cooper, head of Pensions at Durham County Council, reflects on his experience of pooling.
Financial services growth agenda – The sector has been included as one of eight growth-driving sectors for the UK, and the government has made a call for evidence with a strategy plan to be published in spring 2025. The focus is to create a pro-business environment to unlock investment. The sector contributes nearly 10% of the UK’s economy, but has not grown in real terms since 2010. The call for evidence is broad-based, but the priority growth opportunities are seen as fintech, sustainable finance, capital markets, insurance & reinsurance, and asset management & wholesale services. The call for evidence closes on 12 December 2024.
British Growth Partnership – The formation of the BGP was announced at the International Investment Summit in October, with the remit to encourage pension fund investment into UK high-growth innovative companies. The update in the MHS was that Aegon UK and NatWest Cushon have agreed to work with the British Business Bank to support the development of the BGP and provide scale-up funding.
PISCES – This is intended to enable shareholders in private companies to realise investments and to enable investors to access private companies. The intention is for PISCES to be a stepping stone to future IPOs. As an added attraction, the government has confirmed that shares acquired on PISCES will not be subject to stamp duty. The consultation response can be accessed here. The Treasury intends to introduce the legislation for PISCES by May 2025.
The piece that was missing from the Mansion House speech was direct action to increase investment in UK equities, which would provide growth capital, enhance savings, and support economic growth. The pensions review (below) shows strong government support for increased investment in UK equities, but does not yet demonstrate how this will be achieved. We also need to look at ISAs, where the tax advantages to invest in cash and overseas assets make little economic sense. A key priority should be to address the very material short-term issues in the AIM market, where the recent budget measures will result in a further draining out of demand and fundamentally undermine the market. At the very least, AIM needs to be included in the £1m BPR allowance.
The full Mansion House Speech can be accessed here and the accompanying HMT announcement here.
Lord Mayor’s Speech
Alastair King, the Lord Mayor, focused on his theme for the year of ‘Growth Unleashed’. This is to refocus the approach to risk and regulation and to ensure that regulators actively encourage success. The speech highlights the need to re-energise the capital markets and to direct investment into productive assets.
The speech can be accessed here.
Pension review
The interim report of the pension review was released as part of the Mansion House papers. This represents the interim stage of phase one of the pensions review, with the final report to be published in spring 2025. The final report will further consider domestic investment in the UK.
The DWP has also released an analytical publication, Pension fund investment and the UK economy. This looks at historic trends, provides international comparisons, and considers the role of pension funds in economic growth.
Phase two will broaden the review and assess retirement adequacy, focusing on the level of contributions to pensions. In this regard, the UK is well behind most developed nations with a minimum contribution of 8%, and many commentators suggest increasing this to 12% over time. This report from Phoenix Group highlights the importance of increasing contributions both for individuals and the UK economy.
The government has also launched a consultation titled ‘Unlocking the UK pensions market for growth,’ with a deadline of 16 January 2025.
Key points from the interim report include recommendations to:
- Shift focus from cost to value for money to ensure schemes deliver for savers over the long term, with greater recognition of net investment returns.
- Consolidate to create megafunds, with analysis showing benefits of scale starting at c.£25bn, delivering real benefits from an ‘investment capability and economic growth perspective’ when funds reach over £50bn.
- Increased investment in productive assets. DC pensions are expected to grow from c.£600m today to c.£800m by 2030, and LGPS pensions from £392m to c.£500m. Combined, these pension pots are expected to increase by c.30% to £1.3bn.
- Looking at the role of pension funds in capital and financial markets to boost returns and UK growth.
In the interim report, the government stated that it is concerned by the evidence that UK pension funds are investing significantly less in the domestic economy than their overseas counterparts and that there is clear evidence of a sustained pattern of withdrawal by DC and LGPS pension schemes from UK-listed equities for at least the last decade.
The conclusion is that the review will therefore use its next stage to consider whether further interventions may be needed by the government to ensure that these reforms, and the significant predicted growth in DC and LGPS fund assets over the coming years, are benefiting UK growth.
This was reinforced by this article in the FT post the MHS, which highlighted an interview with Emma Reynolds. This emphasised that mandation is not a current position, but is an option if the level of pension investment in the UK does not increase.
There is a wealth of information in the analytical report, which provides clear evidence regarding the current situation in the pension fund market. A key point is the recognition that pension fund investment in domestic markets has the potential to support stronger economic growth and capital market development.
In terms of current allocations, UK pensions’ share of domestic equities is 6% in DC and 17% in LGPS. These are materially lower than the equity share held domestically in Canada (22%), New Zealand (42%), and Australia (45%).
The following chart shows the current allocation of the £600bn in DC schemes:
The DWP estimates that just over 50% of DC assets were invested domestically in 2012, declining to just over 20% by 2023. Much of this decline has been driven by lower allocations to UK-listed equities as schemes pursued global mandates, compounded by weaker performance of domestic markets due to fund outflows and the growth in US markets.
The UK DC market is an international outlier in its total level of investment in domestic markets compared with a selection of other countries. The report estimates that c.22% of UK workplace DC is invested domestically, compared to 44% and 55% in New Zealand’s Kiwisaver and Australia’s Superannuation systems, respectively.
The allocation of LGPS to UK markets is higher than for DC, as shown below:
The LGPS maintain a higher home bias in listed equities than DC schemes, but there has also been a material reduction from c.25% allocation in 2014 to 9% in 2023.
The most substantial decline has been seen in DB schemes, as shown below:
It is estimated that around 32% of DB assets were invested in UK equities in 2006, falling to under 2% by 2023. Allocations to UK-based unquoted equities are low (3%), but rising. There has been a trend towards lower allocation of domestic equities as markets have globalised; however, the UK has fallen further and to a lower level than similar schemes elsewhere.
DB schemes are not included in the current pension review, but there is an active debate around running on rather than buy-outs given the scale of surpluses in the schemes. The PPF estimated that the aggregate DB pension surplus was £474bn in June. One key issue for DB schemes is the level of asymmetry, whereby funding shortfalls are addressed through company contributions, but access to surplus funding is restricted.
The following chart shows the move in pension allocation of DC and DB schemes for equities:
Benefits of ‘home bias’
The report highlights a number of reasons why a home bias might arise:
- Domestic investments provide a natural hedge against inflation and exchange rate fluctuations;
- Higher costs and legal barriers for overseas investments;
- Better information on domestic assets;
- Higher governance and transparency; and
- Greater confidence in local market and patriotism in investment.
This table shows the relative home bias of comparator schemes.
This shows that the level of home bias is materially lower for UK schemes than comparator countries. The US is the only one lower, but this is not surprising given that the scale of the US markets in global indices makes it mathematically impossible to demonstrate home bias. In reality, a larger portion of US pension money is domestically invested.
Domestic investment and economic growth
The report highlights several areas where greater domestic investment can enhance economic growth:
- Deeper, more liquid markets – increasing investment and market capitalisation. More liquid public markets could increase IPO activity and lower the cost of capital.
- Long-term investors – Pensions have long-term investment horizons, which can reduce volatility and provide follow-up capital.
- Start-up capital – Pension funds can enhance start-up and scale-up funding, supporting companies as they grow.
- Supporting productive assets – The long-term horizon can enable pension funds to invest in areas unattractive to other investors, such as major infrastructure projects.
As part of the evidence on returns, the Government Actuary’s Department (GAD) has looked at the impact of different asset allocations with four illustrative strategies.
The outcome of the analysis shows the UK equity-focussed portfolio outperforming the other strategies, except when utilising past performance. The latter assumes the UK equity return is 4% lower than the world equity return. Of course, this incorporates the period when pension funds have been selling down the UK exposure, and it is reasonable to assume returns will improve with increased UK allocation.
What-if analysis
Around 22% of the £600bn of private DC assets are invested in the UK (vs. 55% in 2012). As such, an increase of 5-10% would increase domestic investment by £30-60bn based on today’s scale and £40bn-£80bn by 2030. This would be a substantial increase in domestic investment, which would further rise if contributions levels are also addressed.
Furthermore, if allocation increased to 27-32%, it would still be materially below the level of Australian and New Zealand DC schemes.
