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Embrace Risk for Better Pension Returns While Improving Economic Dynamism

September 05, 2023
David Livingstone, Chief Executive Officer, EMEA

The UK has the second largest pool of long-term capital in the world, with nearly £5 trillion held in pension and insurance funds. Despite the long-term nature of that capital, over the past 25 years the amount domestic investors earmarked for equities, and in particular UK companies, has declined dramatically. This is a tragedy twice over, or what a new think-tank report calls “parallel crises.” 

In UK Capital Markets: a new sense of urgency, sponsored by Citi and abrdn, think tank New Financial argues that the UK pension system is in crisis because of excessive fragmentation and low contributions. The second and related crisis is in capital markets. Many UK investors have all but abandoned investment in UK productive assets, leaving the country reliant on overseas investors for growth capital and funding for critical infrastructure, while denying higher returns to tomorrow’s generations of pensioners.

This situation is costly for all of us who live and work in the UK. Extrapolating OECD figures, a typical UK pension pot might be worth £140k in today’s money after 35 years, assuming a 4% real rate of return and 3% annual increase in earnings/contributions. In Canada, that same pot would be worth £176k, given the better performance of the country’s pension funds. In Australia, it would be an even higher £186k. This means that, on some estimates, poor performance could leave UK savers with £45,000 less in their pension pots than their Australian counterparts. 

The challenges of UK capital markets and pension investing are complex, decades in the making, and the UK Government is to be commended for the energy and focus it is bringing to addressing this long-running issue.

In framing policy to create new incentives to invest in the companies of the future – the next Arm Holdings, or a biotech firm to solve previously incurable diseases – the UK needs to embrace the appropriate balance of risk to deliver inflation-beating returns by encouraging diversification of pension assets at scale.

Perhaps the greatest opportunity is with defined contribution schemes, the largest collection of UK pension assets, most of which are currently active. There are more than 3,000 defined contribution schemes operating in the UK with about £600 billion in total assets, or £200 million each. In Australia, by contrast, there are about 120 “super” schemes with nearly £10 billion in assets each. Consolidating schemes increases the ability to take appropriately managed and diversified risk, which over time improves returns.

There are also more than 5,000 defined benefit schemes in the UK, 75% of which have less than £100 million in assets, too small to achieve economies of scale and the portfolio diversification to invest, at scale, in UK equities. The UK’s superfund regime is currently stalled on the starting grid. The Government should strengthen the incentives for corporate sponsors to transfer fully-funded schemes to new “superfunds,” which have been successful in Australia, Canada and elsewhere. 

Finally, we could kick-start a new era of retail investment by creating a “child equity growth fund” for every newborn. This would, I suggest, substantially improve the nation’s financial literacy and engagement with equity investment, valuable goals in themselves. Investing (say) £3,000 for each child would, over 30 years, raise more than £200 billion of risk capital to fund the high-growth companies of the future.

The scale of the challenge is substantial, but the opportunity is huge. We are hopeful that this topic remains near the top of the agenda and urge the Chancellor to be bold in his autumn statement. 

Please click on the link to the report here

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