Could a pension superfund ignite business growth in the UK?

Pension funds could be used to spur growth in UK infrastructure and the startup and growth sectors, but there are questions over whether the potential rewards justify the risks
Illustration showing a money tap being turned on

Pension funds are traditionally quite conservative in their investments, but there are growing calls to reform the way these massive pools of cash are managed, potentially mandating investments in UK companies, infrastructure and sectors like technology. 

The Tony Blair Institute for Global Change, a think tank, recently suggested creating pension superfunds that “invest in the UK’s economic future”. Meanwhile, Labour have backed a proposed £50bn “future growth fund” and said they may force pension schemes to invest in fast-growing UK companies.

The idea is to use pension funds to kick-start the British economy, particularly in areas like AI and the life sciences.

But the pension industry has hit back against some of these proposals, especially where there is talk of compulsory investments in certain assets.

As Joe Dabrowski, deputy director of policy of the Pensions and Lifetime Savings Association (PLSA), puts it: “We do not believe mandating investment into particular asset classes is a sensible course of action. Schemes are not homogenous, and it’s the responsibility of trustees to ensure their investment approach is appropriate for members’ needs. For defined benefit (DB) schemes, it is also essential to consider the impact on the employer, who underwrites the cost.”

Pension superfunds and consolidation

The Tony Blair Institute proposes expanding the Pension Protection Fund (PPF) to become the country’s first ‘superfund’. Small DB schemes could choose to transfer to the fund, and over time a “series of regional, not-for-profit entities” would absorb the remaining DB funds, the UK’s 27,000 defined contribution (DC) funds, and, potentially, public sector pension schemes.

It claims the changes would secure better returns for pensioners, and boost investment in innovation, the energy transition and in London as a global financial centre.

The UK has chronically underinvested in our own infrastructure and ideas. We need to invest in ourselves again

To encourage DB funds to consolidate, the institute recommends using tax incentives – which would be contingent on a minimum investment in UK companies and qualifying infrastructure assets, such as 25% of assets.

Other ideas include a £50bn fund, with 5% of every DC scheme invested in it – proposed by Nicholas Lyons, Lord Mayor of the City of London, and supported by Labour – and the government’s long-term investment for technology and science (Lifts) initiative, which seeks to alter the risk-return component of an investment, making it more attractive for DC pensions.

The government recently said pension funds must embrace a culture of risk-taking, and chancellor Jeremy Hunt is understood to be mulling over the PPF superfund proposals.

According to a government spokesperson, the aim is to “enhance the growth potential of pension funds – making it easier for them to invest in a wider range of high-growth companies to help increase returns for savers and boost economic growth.”

Do bigger pensions superfunds lead to bigger returns?

Jeegar Kakkad, policy director of the Tony Blair Institute, and one of the authors of its report, argues that the UK has the third-largest pensions market in the world yet none of the top 40 global superfunds, and “this has hurt pensioners and the economy”. 

He says a key benefit is scale. “A bigger fund is able to make better asset allocation and is likely to benefit from the relatively higher, longer-term returns from investing in assets like infrastructure in the UK.”

The report highlights the dramatic reduction in pension assets invested in UK equities and the corresponding rise in bond investments. In early 2000, more than half of pension assets were invested in listed UK equities, while just 15% were held in bonds. Today the figures are 4% and 60% respectively. Kakkad notes: “The UK has chronically underinvested in our own infrastructure and ideas. We need to invest in ourselves again and the superfund unlocks the capital to do that.”

Becky O’Connor, director of public affairs at the pension provider PensionBee, agrees there are economies of scale in bringing pension funds together, saving on the administrative costs of running smaller schemes. And she accepts that the potential benefit of taking more risk is higher growth, which could translate into bigger pensions for all of us. 

The flipside, however, is if the companies receiving the cash are not successful and do not produce returns for pension savers. “This is quite a significant risk,” she notes.

The reality of riskier pension investments

Investments in immature infrastructure or high-growth companies can be particularly risky. According to Dabrowski, “certain high-risk asset classes will only be appropriate for pension schemes in the right circumstances and within the right products, as part of a balanced portfolio. For schemes to invest in UK startup and growth sectors there needs to be a strong pipeline of opportunities, which must be supported by the right economic conditions and incentives.”

He adds that requiring schemes to invest in the same products risks creating asset bubbles.

Meanwhile, mandating a certain percentage of UK investments could also be viewed as risky, given the FTSE 100’s track record and the possibility of missing out on strong performance in other countries. Over the past decade, the FTSE has returned 2.9% on average each year, while the MSCI World Index has returned 9.17%.

There is also the argument that DB pensions are more suited to ‘safe’ assets like long-term debt. Maturing schemes need certainty that they can pay member benefits without requiring extra employer contributions. The DB sector therefore invests heavily in UK gilts (owning 80% of this market), providing the government with a ready buyer and long-term capital for investment.

Jos Vermeulen, head of solution design at Insight Investment, comments that a potential impact of redirecting the money from UK government debt into other assets is “likely to increase financing costs for the government, which will have to be recovered, potentially through higher taxes”.

One of the main reasons for being opposed to mandated investments – and cautious about large-scale change – is that pension cash belongs to the savers. If an investment fails, savers could suffer. The pensions industry argues that their priority should be giving members good retirement outcomes, rather than boosting our economy.

Having said that, there could be other ways to encourage pension schemes to invest in the UK, such as tax incentives on domestic investments, similar to those in France and Australia. And Dabrowski notes that pension schemes do manage trillions of assets, so with the right products, a small investment into UK assets by individual schemes can go a long way.