In an effort to address the issue of chronic underinvestment in the UK, Chancellor Jeremy Hunt recently suggested that defined contribution pensions allocate 5 per cent of their assets into private equity, venture capital, and start-ups. While the idea has sparked considerable debate, it overlooks some critical nuances in how pension systems, financial markets, and trustee decision-making function. It also raises questions about the changing nature of defined benefit (DB) pension schemes.
The UK government has initiated a formal consultation seeking opinions on two significant ideas: encouraging DB schemes to "invest for surplus" by shifting from bonds and gilts to equities and other "productive assets," and establishing a new "public sector consolidator" to manage DB schemes and invest in equities with economies of scale.
The concept of pushing DB schemes back into equities may prove unworkable. Over the years, DB pension promises have shifted from being "with profits" arrangements, where members shared the risk and return of asset performance, to becoming annuities, where members bear no risk. Holding bonds, rather than equities, aligns assets with liabilities and has been standard practice for years.
Encouraging trustees to invest more in equities would require companies to share outperformance with members, which is not financially viable. If companies wish to "invest for surplus," they should do so directly, rather than indirectly through pension funds. It's crucial to recognise that "investing for surplus" is essentially a form of hidden leverage, which often leads to problems.
Another proposal involves allowing companies to withdraw cash from their pension schemes. However, this could jeopardise members' interests and further delay the insurance buyout process, ultimately disadvantaging pensioners.
The government's idea of a "public sector consolidator" also raises concerns, as it would ultimately rely on government guarantees, potentially putting taxpayers on the hook for private sector DB pensions. If the government aims to mobilise capital for productive finance, alternative approaches like creating a public sector pension scheme or issuing gilts for direct investment could be more effective.
In conclusion, addressing the underinvestment challenge in the UK requires careful consideration of the intricacies of pension systems and financial markets. While the government's proposals aim to stimulate investment, they must be assessed critically to ensure they do not inadvertently harm pensioners or burden taxpayers with liabilities they didn't sign up for.
Persuading trustees to hold more equities would require companies to start sharing outperformance again, giving members, say, a quarter of any annual equity outperformance. But giving away some equity upside, keeping all the downside — as companies are on-the-hook to make up deficits — makes no sense.