Professor Michael Mainelli
Tuesday, 10 June 2025, JP Morgan, Embankment
Opium Moments – Asking Questions
I once opened a talk thusly:
“On Saturday evenings I have had the custom, after taking my opium, of wandering quite far, …”.
A quote from Thomas De Quincey (1785 – 1859), Confessions Of An English Opium Eater (1821). This provides what I call an ‘opium moment’ in a speech. Words so incongruous they earn your attention, even in a talk about investment.
As a group, DCIF members are asset managers who believe that a well-designed and diverse investment strategy has an important role in delivering a comfortable retirement for millions of DC savers. So I’ll pose an overall question,
“whose money is it anyway?”,
that in turn raises some opium questions. When you get a tax advance, is the money yours, or the government’s?
Growth Targets
Benjamin Franklin famously said two things are certain in life: death and taxes. He didn’t say which one he thought was most fun. But I like to think I am an optimist… You know the definition of an optimist? Someone who puts aside an hour to plan their pension.
The national narratives about investment in the UK are a smorgasbord of items – some very true and internationally competitive ones are rule of law, treating all comers fairly, property rights, open & fair trade. Some items are of marginal importance – English language, time zone. Some are self-congratulatory and not distinguishing – who doesn’t have heritage, who doesn’t think they’re inventive. Some are based on dubious data twisted for various purposes, foreign direct investment for example. National narratives should not be formed by picking up shiny jigsaw pieces from the floor and pasting them into a frame – they should be consistently reworked artworks of intention.
Economic growth and living standards have stagnated. Since 2019, overall GDP has risen by just 3.4% in contrast to 4.9% in the Eurozone, and over 12% in the United States. The government has, rightly, identified its first of five ‘missions’ as –
“Kickstart economic growth – to drive growth, rebuild Britain, support good jobs, unlock investment, and improve living standards across the country.”
The occupational pension system holds about £2.2 trillion – 78% in defined benefit (DB) schemes, 22% in defined contribution (DC). The DB system suffers from high systemic risk and a data quality debacle of embarrassing proportions. The LDI disaster, driven by regulation, accounting and markets, wiped out a third of DB assets, circa £650bn – a staggering 10% of total UK investment capital.
What is growth? Government officials say, obviously it’s growth in GDP. I disagree. If so, then tell the Royal Air Force’s Red Arrows to fly low and fast over London shattering all our windows and GDP will go up. A more realistic approach would be to set targets for what matters to people – education, healthcare, transportation, the environment, and how we care for the disadvantaged & elderly. We should be looking at quality of life per capita.
On these measures, the UK is easily bested by several small nations, Denmark, Singapore, Sweden, Ireland, Switzerland, just to get going – the largest by population being the Netherlands with 17 million people. But that’s ok because we 67 million are in company with numerous underperformers such as Germany, Italy, France, and Spain, let alone the United States, Brazil, Mexico, or China. So our first opium question is –
“where are the economies of scale in being a large nation?”
Attractive To Investors
Defined contribution investments are an obvious investment source for government – this is where new money is flowing, approximately £32 billion per annum (ONS PSFS). UK equity allocation has been suppressed over the past 25 years – to the point now that it is only about 4% to 5% of scheme assets, as well as underperforming with productivity nil or even negative. The answer to growth is simple, to make investment in the UK attractive again. It is not to force investment into the UK.
Today’s DCIF Report, the appropriately named “Power Shift: The Future of DC Asset Allocation”, stresses the tensions between national growth priorities and optimal results for DC savers. As per this talk,
“whose money is it anyway?”
There are fiduciary duty tensions, risk inequality with public sector DB schemes, and unclear accountability for the performance of UK-focused investments. Should current government economic priorities take precedence over member outcomes decades hence?
Today’s national narratives seem to circle around magic investment trees. A small change to insurance capital requirements or marketing risky assets to Defined Contribution savers will unleash floods of investment. This appeals to the public, the papers, and the politicians because it places the blame for our investment stagnation, our inability to raise funds for infrastructure, or our inability to scale up companies, firmly upon dim-witted financiers or bad regulation, and requires no effort on our part.
At the time of Brexit 9 years ago, the City of London managed 11% of global assets, today, 13%. And 2% of global assets is a big number [aside: jobs in the City in 2016 were 525,000, and 678,000 at the end of 2024]. A British success story. These fantastic fund managers draw 13% of 8 billion people’s money to be managed by less than 1% of the global population through superior performance.
So, a second opium question,
“which hypothesis is more likely, that our excellent UK financial community accurately evaluates 194 other countries but is blind to opportunities on its own doorstep in its country of residence, or that the UK might need to improve itself as a place for commerce & investment?”
Do we need better marketing or better product?
Delivering The Social Contract
Government is the entity with a monopoly on the use of force in a specified geographic region. The social contract starts with defence, from Ukraine to the cyber-sphere to space. The state taxes us based on the geographic region, creating tax credits we call fiat currency. The social contract extends to the rule of law. Taxes are expected to provide a decent lifelong living, so the social contract extends to skills, trade, infrastructure, and pensions. The social contract extends to the quality of returns on state expenditure.
Thus the social contract expects value for money measured in two ways, quality and quantity. As we know there is general disquiet about the quality of education, healthcare, and infrastructure, aligned with damning international comparators.
The second measure, quantity, is the % of GDP taken by the state. Last year I dealt with a small firm that had obtained a US$750M investment to build a production plant and scale up employment from 25 to 500. They were leaving the UK to do so. Why? Because 44% of the UK economy is the state.
I am reminded of the old saying:
A fine is a tax for doing wrong.
A tax is a fine for doing well.
As Earl Wilson quipped,
“There’s only one kind of tax that would please everybody – one that nobody but the other guy has to pay.”
There is some large state vs small state politics here, as well as Value for Money leading to combinations of high, or low, % of GDP and high, or low, quality infrastructure. We are at 44% of GDP with low quality infrastructure. Some numbers to chew on:
France 56.99%, Sweden 47.49% but remember Swedish infrastructure, then Japan 41.16%, United States 36.28%, Switzerland 31.95%, Ireland 22.65%, Singapore 20.07% (Source: IMF).
Research by PWC for UK Finance showed that the total tax rate for a bank in London was in 2023 was 45.5%, higher than New York at 27.9% or Dublin at 32.4%.
So a third opium question,
“Do you want to locate large, expensive, immobile assets for long periods in a place where nearly half of your profits will need to be appropriated?”
Our investment managers are making rational decisions. We need a more efficient state delivering better infrastructure. A better product is hard work, not just tweaking marketing gimmicks.
Long Finance
Twenty years ago Z/Yen launched the Long Finance initiative, asking the question
“when would we know our financial system is working?”
even before the financial crises.
One permanent question might be,
“can a 20-year-old responsibly enter into a financial structure for his or her retirement?”.
Such a question raises a host of related issues. The question draws in actuaries, accountants, life insurance, savings, investments, security, fraud, risk, returns and firm defaults. An average 20-year-old today should, under reasonable actuarial expectations, live to 95. Most 20-year-olds with whom I talk assume they’ll live to 120. So the question implies a financial structure that should last 75 to 100 years. Looking over the past 75 to 100 years that covers two world wars and, since 1970, 1973 Oil Shock, 1982 Third World Debt Crises, 1987 Black Monday, 1988 Junk Bond Busts, 1990s Japanese Bubble, 1994 US Bond Crash, 1995 Mexican Crisis, 1997 Asian Crisis, 1998 Russian Crisis, 1998 Long Term Capital Management’s failure, 2000 Dotcom Crash, 2001 September 11 Disruption, 2002 Argentina Crisis, and, of course, more recent events.
When discussing Long Finance with the German ambassador to the UK, he pointed out to me that his grandfather, who started his pension in 1916, drew it down in the 1960’s after two world wars, the Weimar, etc., while many English and USA pensioners lived in poverty. His point being that financial structures are social constructs. Anglo-Saxon socio-financial constructs need a lot of work.
The recent Mansion House Accord encourages schemes to allocate 10% of assets to private markets by 2030, with 5% specifically in UK-based investments. This encouragement sits alongside scheme consolidation and a move to a value for money framework rather than a cost control framework. Progress will depend on having a steady supply of high-quality UK investment opportunities.
Most of this Accord discussion is airing some good thoughts, but the one frightening element is that the government’s Pension Schemes Bill includes a reserve power which would enable the government to set quantitative baseline targets for pension schemes to invest in a broader range of private assets, including in the UK. In many senses, restrictions on investment opportunities is mandation of a form, but here we’re moving from ‘passive mandation’ to ‘active mandation.
As Con Keating pointed out to me,
“Without good UK investment opportunities, mandation of UK investment is likely to produce poorer investment returns relative to the opportunities elsewhere – which rather defeats the purpose of privately funded pensions, i.e. reducing dependence on the state pension.”
Own The World – Diversification
Alongside the politics of growth, there is the growth of portfolios. Our Anglo-Saxon models of risk-reduction are based on portfolio diversification. John von Neumann cursed that,
“Anyone who attempts to generate random numbers by deterministic means is, of course, living in a state of sin.”
Mark Twain’s contrarian, anti-portfolio saying (from Pudd’nhead Wilson) goes: “Behold, the fool saith,
‘Put not all thine eggs in the one basket’ – which is but a manner of saying, ‘Scatter your money and your attention’, but the wise man saith, ‘Put all your eggs in the one basket and – watch that basket.’”
But we disagree as a financial sector. We believe in diversification and the mathematics behind portfolios. We believe in portfolios over products. A precipice bond may actually be the right choice for an overly safe portfolio, paying off the mortgage first may be the right choice for an extreme risk taker. There are few actually bad products, just products not right for a portfolio.
Tax is at the heart of defined contribution and pensions. The social contract is that the state relieves you of early taxation to encourage you to save and grow your wealth, while you relieve the state of paying for your retirement. The most simple system would specify what are qualifying tax-free investments and let you go from there. Each year you would be assessed on your increase in qualified investments deducted from your income, or decrease added to your taxable income. Yet we don’t trust you to invest your money, so we add lots of complexity and controls, and restrict your diversification.
Were all things equal on a per capita basis, a low-risk UK investor should hold less than 1% in the UK based on population. Perhaps though we should look at the UK as about 3.25% of global GDP, so a bit over 3%. However, there are low local growth rates to contend with, perhaps leading to a bit less invested in the UK. Yet, there is also local knowledge, so a bit more invested in the UK. So over 3% certainly, but much less than 50%. In discussions last year with Chinese pension policy makers, they understand that their 7% investment overseas is too low and should be over 50% despite China’s size and relatively high growth rate.
Social Contract Discussion
Yet public goods and welfare must be financed. Edmund Burke declaimed,
“there is no such thing as a good tax”.
I heard that Donald Trump is proposing a tax on shredded cheese – part of his plan to Make America Grate Again. Wait for a thousand pages of “The One, Big, Beautiful Bill”, in the United States and their tax implications. High taxes become self-defeating. What you tax, you get less of. Tax trade, less trade. Tax employment, less workers. Tax capital, less investment. Every tax reduces its own base, thus raising other taxes which in turn reduce their tax base, leading to new taxes.
Personally, I would like to hear more consideration of radical reforms and simplifications. A land value tax (LVT) is a tax on the unimproved value of land, excluding the value of buildings or other improvements. The idea is to tax the location and natural advantages of land rather than the work people do to improve it. Land value tax reduces real estate speculation, encourages development of vacant or underused land, and provides stable public revenue. Sir John Cowperthwaite introduced it in Hong Kong in the 1950s and it transformed that city’s economy so much it went from the GDP level of Jamaica to wealthier than Britain at handover in 1997.
Well beyond tax, we need numerous UK investment environment improvements. Are we smoking opium when we suggest reforms such as – planning; brownfield land reinsurance to free up land transfer and build homes; reducing energy costs; property liquidity and the Danish mortgage market model; employee share ownership policies; SME collective loan investment schemes – reverse-convertible debt markets; university fees insurance to grow education exports; cyber-catastrophe insurance-linked securities; banking competition; audit competition; smart economy networks and identity?
To cynics, today’s societal and government inertia seems to have a momentum all of its own. To provide an opium suggestion, every day we should ask,
“how do we make the UK a much better investment product much faster?”
Ill-defined Pension Space
Among my charitable interests is ‘financial literacy’. We know defined benefit is closing, and the government approach for much of the civil service is unfunded final salary. I agree with Douglas Flint that using the word ‘pension’ after ‘defined contribution’ is a financial illiteracy abomination of the highest order unless we guarantee an income providing a certain living standard. Real financial literacy moves beyond the mathematics of compound interest into politics and economics.
A worrying aspect of much underfunded retirement is the political pressures that might lead a rational working person to buy watches, jewels, cars, and other stores of value, things they can sell in retirement, then upon retirement ganging up with fellow impoverished pensioners to lobby for rapidly increasing state pension levels. Some late night discussions have tried to explore how civil service attention to the economy might be improved by tying their pensions more closely to national economic performance whether through indices or windfall taxes on excess benefits over private sector pensions.
What Risk Are We Addressing?
I was an international expert helping the State of New South Wales with superannuation problems over three decades ago. There is much to admire about the ‘Supers’ but it was a different culture, a different time, and a different risk we were addressing. Until recently, with discussion of collective defined contributions, our national philosophical approach to pensions has largely been to prioritise individual ownership over the collective.
I once heard a story that HMRC contacted a priest and said they were investigating the tax affairs of one of his parishioners. They asked the priest:
“did this gentleman really donate £10,000 to the church?”
The priest thought for a moment, and replied:
“he will.”
If DC is about retirement income, why do we encourage tax-free lump sums? An Economist article from December 2024,
“How much happiness does money buy?”
delved into the concept of diminishing marginal utility of income, exploring the nuanced relationship between wealth and well-being, emphasising that while increased income can enhance happiness, the returns diminish as income rises. This insight has significant implications for defined contribution pension schemes – the goal should be adequacy over excess, to secure a retirement income that covers essential needs and provides a comfortable lifestyle. Our emphasis should be on achieving financial security and personal fulfilment rather than solely maximising wealth. If DC schemes focus more closely on adequacy, then we can retain simplicity, not trying to encompass everything from mortgages to care in one savings scheme.
No Mandate For Mandation
For centuries, British economic thinking has been influenced strongly by three traditional ethical liberal values – individual rights, freedom of speech, and protection of property. Those three ethical values imply three practical values – limited government, open markets, and free trade. Is mandation equivalent to desperation?
The frightening bit about mandation is the potential harm it does to concepts of protection of property. What makes finance special from other industries is the permission to use leverage – fractional reserve banking and pooling. We have an opportunity with some of these reforms to pool loosely and gain some collective benefits.
We can take a much more contractual approach. Historic savings invested should not be mandated, while future savings could come with a variety of mechanisms making them attractive and supporting the government’s growth mission.
For example, rather than risking a series of landmines about what is or isn’t a UK investment, the government could specify specific important investments or pieces of infrastructure and provide financial incentives and guarantees. Make the UK attractive again by removing stamp duty on UK companies, however defined.
The government could be much more ‘contractual’ on venture capital style arrangements where it is involved, guaranteeing a base return or no-loss situation. Policy performance bonds, as issued in Chile, Uruguay, and Thailand, guarantee that the government will attain certain climate emission targets and certain renewable energy targets or the interest rate on the bond increases. These sovereign sustainability-linked bonds provide a solid hedge for investors in solar and wind against government policy risk.
One approach might be to move more strongly to an old annuity-style approach, by declaring at what point the government will guarantee some solid pension provision based on remaining life expectancy rather than retirement age. Say ten years. If in 2025, life expectancy is 82 years, the government declares that the final years for those over 72 are now guaranteed onward. If the age rises in 2030 to, say, 87 years, then the final guaranteed decade is from 77.
Our City’s strategy, certainly since the 16th century, has three virtuous components – create wealth, improve our business & physical environment, and share our prosperity. Our economy is built on four foundational themes:
- Defence and security – remember, people don’t bring money to a war zone, nor to a cybersecurity hazard;
- Rule of Law – in its widest sense, arbitration, mediation, expert determination, conciliation, and an all-round fair environment;
- Free, fair, and open trade;
- Access to the world’s best talent and skills.
The many proposed reforms need an airing, but the one thing to avoid is mandation, which breaks the rule of law on property in the same way as retroactive taxation or politically-motivated nationalisation. We can achieve the same outcome by government contracting with savers about attractive UK investment, without the need to violate property rights. Attract more flies with honey than vinegar.
Churchill contended that
“… for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”
We cannot tax ourselves into prosperity, but we can design an economy that encourages entrepreneurs, attracts investment, and keeps the UK competitive.
In my day job, clients often plead at the end of a long day of comparative statistics,
“please just give us one thing that will lead to a successful commercial centre”.
My simple answer is,
“treat all comers fairly”.
Not surprisingly the World’s Capital City has an informal motto for that, meum dictum pactum, my word is my bond.
UK investment depends on treating all monies fairly. So let’s be clear that defined contribution monies are the savers’ monies, not the government’s.
Thank you.
