The term “strategic investments” is used in two different ways in the financial world. In the first sense, it applies to investments made by individuals or companies with the goal of generating safe, steady returns, usually with the advice of a consulting company which keeps up with trends in the market and addresses the needs of the customer. This term is also used to describe a company’s decision to invest in another, smaller company, usually a startup, with long-term strategy in mind, rather than simple profit.
In the second sense, strategic investments are often used to raise capital and credibility for new companies which are struggling to make their way in the market. Larger companies make strategic investments in smaller ones for an assortment of reasons. For example, a big company might invest in a smaller company which makes similar products, or in a small company which will eventually become a client of the big company. Forward-thinking companies may also want to make strategic investments in companies working on new and innovative technologies and ideas.
As you may have guessed, I had to look up the meaning of “strategic investment” . Thank you to Mary McMahon for helping me out.
Today I am heading south to fly north to Loch Lomond to address the question posed in the title of this blog.
Many – including it seems the Government, seem to have given up on large parts of the funded pension market to a point where they have not included corporate DB pensions in its current Pension Investment Review.
Since I’m mainly involved these days in creating an “agewage” by converting DC pots to DB pensions , you may be asking whether this is anything other than a jolly. But I go to participate in a panel with my friends Luke Webster and John Harrison and I am to be a Devil, opposing the received ideas of the conference.
If the Conference takes as a premise that we are likely to see DB pension schemes investing in smaller companies with the aim of a steady return over the long term from smaller companies, then I suspect most of the delegates will be in schemes with a long future. Or should I say “scheme” as the only DB pension scheme that makes it into the Government’s Pension Review is the LGPS. The LGPS isn’t so much one pension scheme as 87 pension funds embraced by one scheme and the Government clearly wants there to be the same number of funds as there is a scheme- “one fund- one scheme”.
This is how Government wants LGPS to invest more strategically, by investing primarily into the growth areas of the (UK) economy and not dumping member’s money into non-strategic assets – the global markets of listed bonds and equities.
(UK) goes into brackets because the Government is still a little shy about its agenda, but we can be pretty sure that with a £22bn reported deficit in public funds, it would rather see pension rather than tax-payer’s money doing the heavy lifting.
And the Government can reasonably argue that a proportion of pension money is tax-payer’s money as tax foregone on pensions amounts to as much as a third of the money in the LGPS (and all the other DB pension funds).
I am being asked to be a devil
I am a devil to be saying that corporate DB pensions aren’t quite dead yet. Looking at the scheme accounts of USS as I did over the weekend, I say plenty of evidence of scheme investments
Not only is USS investing strategically , it is making money from its strategic investments. Indeed it is expecting to make more money over time from its strategic investments than from any other part of its £73bn portfolio, this despite the odd aquatic hiccup.
So my trip up north will be in part to bang the drum for that most neglected area of pension investment, the DB scheme which could and should be given the time to invest strategically by being able to run on. Whether this is through real superfunds (not the bridge to buy-out variety) or through capital backed journey plans or through schemes with strong sponsors and strong funds like USS, DB schemes can run on,
So I will leave you with my favorite diagram from my friend Derek Benstead to explain why the DB sweet spot is infact the sweet spot for DB strategic investment (and CDC too!).
Is a DB Pension Scheme in surplus a strategic investment of the sponsoring employer?
It should increase the net worth of the employer, primarily by giving the company and its owners the opportunity to trade with lower reported employment costs (with the estimated interest on the opening surplus reducing the P&L A/c Administration costs). This is irrespective of whether there are increased opportunities for surplus distribution in times of company crisis as was suggested in the DWP consultation, although from the company’s point of view that is relatively inefficient as the surplus has to be shared with the members. There are however few problems with an open DB Pension Scheme in using the surplus towards a contribution holiday.
On a cash flow basis, it may indeed be attractive to the employer to overfund the pension scheme as this provides it with a tax efficient investment vehicle. The tax relief on contributions is not available to a company with a closed pension scheme in surplus, but is available if benefits are still accruing.
Is DB pension accrual really dead in the private sector? The DB Pension Scheme in surplus should increase the company’s value and attractiveness to a potential bidder (even if the potential purchaser is only wishing to acquire the company to open the pension scheme to new members, whether employees or not – a capital backed journey plan)!.
The most important strategic investments for DB schemes are those that deliver a steady income return (CASHFLOW) between one and four times a year!