“When we asked more than 1,000 people with a pension what they thought, we found that they were more interested in more of their pension being invested in the UK than solely in performance.” – New Financial
The think tank in question is New Financial (William Wright the author of their report)
It is increasingly evident that savers are not aligned with investment advisors, trustees and fund managers, they want investment to be made in the UK because they consider themselves British.
On average, those surveyed thought that about 40 per cent of their pension was invested in the UK stock market, compared with only around 7 per cent in reality.
DC pensions in the UK currently hold about £33bn in UK-listed equities, according to New Financial. This could rise to around £109bn if UK equities represented 19 per cent of all equities in pension default funds, which are designed to meet the needs of the average member.
This would rise to £128bn if the government went one step further and forced all DC pension funds to invest a fifth of all stocks in the UK. So far, the government’s focus has been on driving more investment into domestic infrastructure and private equity, after coordinating a voluntary accord under which 17 of the largest DC pension providers committed to invest at least 5 per cent of their default funds in UK private markets.
Here is a short summary of the report:
Why it matters: this report argues that a more vibrant public equity market matters for people in every corner of the UK. It would help support growth and investment through the big local footprint of listed companies across the country, enable more high-growth companies to scale-up and stay in the UK, better connect millions of individuals saving for their pension with UK companies, and send a strong signal on investing in the UK.
Decision time: this report adds a valuable practical perspective to the debate over the past few years on the decline in how much UK pension funds invest in the UK stock market by analysing five different options for the reform of defined contribution pensions based on their potential impact and ease of implementation.
A vicious circle: the allocation to UK equities by DC funds has fallen from around 40% of their total allocation to equities to just 9% in little more than a decade. They now allocate just 4.9% of their assets to UK equities (about £33bn). On both counts, this is significantly lower than the global average for DC pensions of over 13% of assets in domestic equities, and nearly 30% of total equities invested in domestic equities.
The easy option: the ‘do nothing’ option may sound attractive to many in the industry but under this scenario things would probably get worse before they get better. By 2030, investment in UK equities would fall to just 3.5% of DC pensions assets as more funds shift to a ‘global market weighted’ approach.
The complex options: the proposals to change the tax relief on pension contributions and increase the tax-free lump seem attractive but would have a middling impact on investment in UK equities of between £40bn and £50bn compared with today’s level of investment. These options quickly become very complicated to implement mainly because they would operate at an individual level rather than at a scheme level.
The nuclear option: if the government mandated DC pensions to invest a minimum of 20% of 25% of their allocation to equities in the UK market, investment could more than quadruple compared with today’s levels. However, this option would provoke a fierce backlash and would mean the UK joining China, Hong Kong, and India as the only countries that mandate a minimum investment in domestic equities for their pension funds.
The balanced option: the UK weighted default fund could have a game-changing impact on investment in UK equities with growth of up to £95bn from current levels, and it would be much less challenging to implement than the other options. A potential allocation to UK equities of around 20% of all equities may sound high but is roughly where the industry was as recently as five years ago.
A mismatch in expectations: our survey of more than 1,000 working adults in the UK with a pension highlighted a low level of understanding of their pension and a stark disconnect between their expectations and the industry. On average, people thought 41% of their pension was invested in UK companies or the UK stock market (out by a factor of five to 10 times), and two-thirds of people said pensions should invest more in UK equities even if the returns might be lower than investing in other markets.
The debate on diversification: one of the most striking trends in UK pensions over the past decade has been the shift from a ‘UK centric’ approach to a ‘global market weighted’ approach in the pursuit of better risk adjusted returns. However, being ‘globally diversified’ is the not the same thing as (and does not require taking) a ‘global market weighted’ approach. Pensions could capture the benefit of diversification while retaining a much higher allocation to UK equities by investing on an equal weight basis in a relatively small number of markets.
The next steps: pensions legislation and regulation is fiercely complicated so we have prepared a practical guide to the specific legislative and regulatory steps that the government would need to take in order to implement each of these options. There is a window of opportunity to amend the Pension Schemes Bill as it works its way through Parliament. If the government wants to make a game-changing intervention in this debate (and we think there is a strong case for it to do so) we would recommend pursuing the ‘UK weighted default fund’ option.