People do not want their pensions to be at risk, so we need to be a lot more imaginative

Pensions savers instinctively understand what pensions are for, despite the efforts of policy-makers to co-opt pension funds into a failing economic strategy

For as long as I can remember, policy-makers have been telling us that, if we want to reorient the UK economy towards an investment-led development model, we need to ‘unlock’ pension funds. The result would be a more regionally balanced economy, investing more in infrastructure or advanced manufacturing or green technology, and building more affordable houses.

Private pension schemes (from the traditional, occupational pension trusts, to the assets held by insurance companies for the purpose of providing a retirement income in contract-based provision) are hugely significant economic institutions, possessing assets worth more than 100% of UK GDP. Funds tend to be allocated, however, to conventional assets like shares in listed companies, or public debt.

Where they are invested in ‘alternative’ assets like infrastructure, pension funds rarely got involved in the earliest, riskier phases of large-scale infrastructure development, preferring instead deals where revenues are more predictable. And a turn to private equity is about short-termist investment in asset-stripping firms, just as much as blue-sky investment in innovative technologies.

This is a disgrace, as Liz Truss might say. An entire generation of Conservative politicians from David Cameron and George Osborne onwards have insisted that UK pensions be put to work in domestic (economic) service, but actually failed to achieve very much, if anything.

There are two main, overlapping problems. First, it has proved very difficult to devise policy solutions which allow for riskier, long-term investments without jeopardising the security of future pension incomes. Second, individual pensions savers have little appetite for risk, even if it could be demonstrated that it might support a better economy for all, and indeed higher returns for themselves (not always, but more often than not).

What members want

My book Pensions Imperilled details the waves of policy discourse around the notion of long-termist pension fund investment, as well as the financial realities and economic contexts which have seen each wave peter out. But it does not say very much about preferences among members of private pension schemes in this regard — because pensions savers are rarely asked what they think.

A recent report on this topic by Ben Franklin and Norma Cohen, published by the Centre for Progressive Policy (CPP), is therefore very welcome.

It is also abundantly clear:

‘the general public overwhelmingly prioritises the return on their savings over any broader social, economic or political objective’.

In a nationally representative poll commissioned by CPP, when asked to select their top three priorities for pension scheme management, more than four-fifths of pensions savers prioritised maximising returns, and around two-thirds prioritised minimising risks. Less than a third prioritised investing in a way consistent with their social or ethical values, and around one-sixth prioritised investing in their local area.

“Thinking about how your pension savings are managed, what issues do you think should be prioritised? Please select three options from the list below, ranking them in order of priority.” (NET: top three priority)

CPP also asked survey participants what range of investment returns they would consider acceptable, based on whether or not their savings were being invested in companies that were having a positive social and environmental impact. As the chart below shows, the range of acceptable returns is almost identical, irrespective of the wider impact.

“Imagine you were offered a pension that a) invested in a range of companies or assets that have no positive impact on people or the environment, or b) actively invested in a range of companies or assets that did good for other people and/or the environment. What return, from a starting investment of £10,000, would make this acceptable?”

Disappointment

This will be disappointing news for the politicians who have long hoped that private pension fund investments could make up for the inadequacies of long-term investment by the public sector. But it will also be disappointing for many on the centre-left who have campaigned for pension funds to become more responsible corporate stewards, that is, taking a long-term perspective on the companies they invest in, rather than passively tracking indexes for predictable, short-term returns.

And to be clear, we should be disappointed. Pension funds are no substitute for public investment, but in the absence of the latter, and in a corporate governance system underpinned by ruinous ‘shareholder value’ norms, financial institutions like pension funds could help to nudge the economy towards a more sustainable development model.

It is unfair of course to place this burden on pensions savers alone. And crucially, as I argue in Pensions Imperilled, this agenda — even in the hands of the well-intentioned — contradicts what pensions essentially are. Although in the UK we have moved worryingly far from this understanding, the point of pensions provision is to provide an institutional anchor which protects our future income against uncertainty.

Retaining value is, or should be, the be-all and end-all. People think about pensions like bank accounts, not investment vehicles. Indeed they often think about private pensions saving in the same way as paying into the state pension, that is, as a form of taxation. In other words, entirely risk-free.

This may sound like a naïve perspective, but it is fundamentally correct. In fact, capitalism depends on it, in order to reproduce labour, far more than it depends on being able to invest our savings in stocks and shares.

Guilty as charged

In their report, Franklin and Cohen rightly use the above results to criticise the current government’s attempt to alter ‘the charge cap’. Most private sector workers have been automatically enrolled into individualised ‘defined contribution’ workplace pension schemes (rather than collectivised ‘defined benefit’), in which their retirement outcomes depend entirely on how their investments perform, without any employer guarantees.

Because (a) most individual savers have no capacity to manage their own pensions saving, (b) most people being auto-enrolled are not members of a trade union, and (c) charges eat into investment returns, the charge cap was introduced by former pensions minister Steve Webb (a Liberal Democrat) in order to provide a degree of protection. It applies to savers automatically enrolled into the ‘default’ strategy for their scheme, so does not protect those who make an active choice over how to invest their savings.

The problem, however, is that the riskier, long-term investments that policy-makers want pension funds to reorient towards tend to be more expensive to set up. They require research, relationships, and active management — they are not made via public exchanges and auctions. Where charges are capped, the asset management firms contracted by pension funds argue they cannot afford to provide these opportunities.

It is worth noting that this change was first attempted by the May government. We appear to have reached the stage whereby the rate at which the Conservative Party is recycling failed policies is increasing exponentially.

The charge cap is an imperfect solution, but it is essential to a workplace pensions system where people are auto-enrolled into individualised provision. The cap is already somewhat generous to providers (i.e. set at a level above the prevailing market rate for scheme charges), and scheme governance rules are not strong enough to prevent abuse if it is removed or diluted.

Most importantly, there is no guarantee that higher returns will result from the riskier, more complex investments. If we are going to treat pensions as a consumer product rather than a secure form of income deferral, then consumer protections are necessary. Individualisation has made the reorientation of pension fund investments even trickier than it already was.

Possible reforms

There are a series of other measures which could be introduced to support long-term investment by pension funds. Ultimately, the state will probably need to take on more of the risks of long-term investment, and allow pension funds to piggyback. Canada and Australia crop up repeatedly as examples of ‘Anglosphere’ economies where pension funds invest a great deal more in infrastructure than UK funds, but it is rarely noted that their governments invest a great deal more in infrastructure too.

More specifically, the state could offer infrastructure bonds to allow pension funds to finance public investment in physical and social infrastructure. This idea has of course been doing the rounds for years. Its main drawback is redundancy: there is no reason that the state could not finance long-term investment from conventional borrowing, which pension funds are already enthusiastic participants in.

Arguably, the biggest prizes come into view when we consider reforms to investment practice alongside redesigning the benefit structure of private pensions. This agenda would require a little more imagination! The government could, for instance, reintroduce a state second pension (replacing the private pensions industry, more or less) but hypothecate tax contributions to finance something like a sovereign wealth fund.

This would be a very radical shift, but the existence of the state-managed National Employment Savings Trust (NEST), for customers deemed unprofitable by the private sector, means it is not as far away from current practice as we might assume.

Another option would involve reforming pensions tax relief (PTR), which costs around £20 billion per year. I refer to PTR as an ‘exorbitant irrelevance’: it has no impact on saving incentives, and it disproportionately benefits higher earners. People who choose an investment strategy which encompasses riskier, long-term investments could be rewarded with higher tax reliefs; they would personally make the same contribution, but receive a larger state subsidy in return for a slightly higher risk profile. Any such system would need to be carefully designed to ensure that the investment strategies attracting greater volumes of PTR support were genuinely resulting in a socially useful asset allocation.