Investment and Growth

Con Keating

Introduction

The exhortations for pension funds to invest for growth have been widely publicised in recent years. It has been, and remains, government policy. Unfortunately, ‘growth’ investment seems to have been interpreted in a very narrow and incomplete sense in the funded pensions world; largely limited to public and private equity.

There seems to be much confusion concerning this issue both in pensions and policy. For example, a pension fund subscribing to a new issue of corporate bonds is contributing to the growth agenda, when that corporation is using the proceeds to finance part, or all, of its new productive commercial investment. The use of proceeds has always been relevant for any corporate financing. From an investment and growth standpoint however, some uses, such as the repurchase and sterilisation of shares issued to management, are highly questionable.

Setting aside for the moment the possibility of a pension scheme itself borrowing to finance new investments[1], it should be recognised that new issuance of securities to fund investment requires new savings for its purchase.[2] All too often we see the levels of new gilt issuance being compared to the (market-valued) stock of pension fund assets. However, those assets are already invested. For this to be a relevant comparison, there would need to be buyers who are ready, willing and able to buy those existing pension fund assets present in the markets. The question then becomes one of relative value to the different participants.

It should also be noted that the purchase of existing securities such as listed equity does not advance the growth investment agenda unless the funds received by the seller are invested with that purpose in mind.

Flows of Funds into and out of UK funded schemes

Defined contribution schemes have become the principal recipient of new savings since the introduction of auto-enrolment and the closure of all but a few of private sector DB schemes. Although it is worth noting that the sponsors of the few open DB schemes that remain contributed £6.97 billion in respect of new awards.

In the year ended Q3 2023, DC schemes saw net inflows from contributions of £34.5 billion[3] and held total assets of £249 billion. However, £23.3 billion of these contributions came from employer sponsors and these schemes paid £3 billion of pension benefits.

Local Authority schemes saw total contribution inflows of £14.7 billion, but paid benefits of £18.1 billion to pensioners. The shortfall must be met from the income on the £499 billion of assets held. Unfortunately, the ONS dataset does not provide investment income statistics. However, for this shortfall to be met from investment income requires a rate of income of just 0.7%. If 3% is the achieved rate of income, public schemes have £9.6 billion of new funds available for investment.

Private sector DB schemes paid pension benefits of £49.7 billion and received contributions of £18.6 billion, of which £8.0 billion were employer-paid deficit repair contributions (DRCs). The income return on the £1,123 billion of DB assets held needed to meet the £31.1 billion shortfall is 2.8%.

As employer contributions reduce their funds available for investment, consideration of the returns needed in the absence of these is relevant; the shortfall of £39.1 billion required if all dependence on employer sponsor DRCs is eliminated is 3.48% and eliminating all sponsor contributions would raise the required rate of return to 4.32%. It is therefore unlikely that private sector DB schemes can be the source of any significant new investment.

The final potential source of new investment in growth assets would be the proceeds of maturing debt instruments. However, for private sector DB, this is reported as only £10 billion and for public sector schemes just £2 billion.

To give these figures some overall context, these pension funds represent 40% of the £4.8 trillion national capital stock. Of the £490 billion of fixed capital formation reported for 2023, £269 billion was business investment.

It appears likely that any commitment to ‘growth’ assets from the private DB sector will have to come from a reallocation of existing assets. These scheme account for more than half of all funded schemes assets. There are considerable barriers to this departure from the now-dominant ‘de-risking’ asset allocation strategy, quite apart from identifying buyers for the assets to be sold. This latter issue is particularly relevant given the scale of proposed gilt issuance and the Bank of England sales of gilts under quantitative tightening.

Conclusions

There are therefore two major concerns with the policy of pension scheme investment for growth; the extent to which this is feasible for schemes and the significance of this investment in terms of its ability to move the dial with respect to an overall GDP of £2.8 trillion even if effected to the maximum extent possible. Although investment for ‘growth’ may contribute to achieving that objective, it seems likely to be only a small part of wha

[1] Iain Clacher and I have made the point at length that we believe borrowing for investment purposes by DB schemes is not lawful.

[2] Of course, private sector DB schemes have borrowed using repo, as was seen with disastrous consequence in 2022. The ONS reports this borrowing at £115 billion or 10% of assets in Q3 2023, which is broadly in line with the extent of leverage prior to 2022.

[3] Office for National Statistics Financial Survey of Pension Schemes