Debate has opened on how pension funds might work better to serve the economy. The Chancellor has asked for bigger commitments from the largest funds to foster technology businesses and those not yet listed on the stockmarket. This follows years of failure by the UK to nurture homegrown young businesses; evident in low economic growth, lack of innovation and poor productivity. Stock market reform may also be needed; new listings on the London Stock Exchange have been scarce over the past year and some global groups are shifting their listings to New York. Realising the need for change has come belatedly - now there must be no delay in acting.
There is no shortage of assets; UK pension funds total more than £2.5 trillion, the largest in Europe and second only to the US pensions market globally. But over time UK funds have cut their allocation to British-based companies to very low levels, bringing down the valuations of many UK businesses in the process. The de-rating of those British companies relative to their international peers makes it harder and more expensive for them to raise new capital. The process certainly accelerated with Brexit and UK political turmoil, but more recently it has seemed to be driven by financial regulation and some debatable guidance on risk and returns from pension fund advisers. Much of the UK problem seems self-inflicted.
For the London Stock Exchange, pastures seemed greener overseas. At one time it embraced regional exchanges across the UK. But in recent years its business model has primarily become to attract big global businesses to list their shares in London. Now, London faces tough international competition - from New York in particular - all vying to attract listings from big multi-nationals. Britain’s institutional investors are less significant globally, and other financial centres with lower governance standards are winning out. Britain has also been held back by an approach to charging for company research that severely hampered smaller companies. Europe adopted the model but now looks set to unwind, following the US move back to a more traditional financing basis for research.
The data also suggests that UK employees contributing to pensions that are based on investment performance have been short-changed. Investment return of the average UK pension fund over the last ten years has lagged its peers in Australia, Canada and the Netherlands, significantly reducing the rewards at retirement. It looks like too little risk has been taken in the mix of assets used to manage the UK funds. Generally more investment in shares would have helped performance, given the very long term nature of these funds and the need to beat inflation. But the Chancellor has focused on a more contentious issue with the UK funds; unlisted assets, and private equity in particular.
Historically, there has been good performance by pension funds that held more in unlisted investment, often capturing an early faster growth stage of businesses. This need not always be in technology, but it is typically in unproven business models that will need more management and capital as they develop. With good investment expertise and diversification it may be that a very small allocation to earlier stage businesses will pay off for pension funds. But now nine leading pension funds have agreed to raise their investment in unlisted shares, to at least 5% by 2030. This commitment looks like too much, too late. It seems rushed and may not help either the UK economy or investment performance.
Already there are signs that the halcyon days of private equity are gone, with asset values falling and many technology businesses struggling. The run of good performance may have been helped by a tailwind of tax breaks and a period of technology innovation that is now in the rear-view mirror. Although there were some notable successes in technology value creation, such as Skyscanner, a lot of tech businesses have destroyed spectacular amounts of capital and may never become profitable.
But simply labelling unlisted and other illiquid investments as ‘productive finance’ does not make it so. Some of the types of assets suggested are relatively unproven - it is not until an asset type has been tested through a number of business cycles that risks are fully understood. And without the right skills within pension funds to value and manage these unconventional assets the change could mean an avalanche of money chasing some dubious propositions.
The wider economy may have more to gain by allocating funds to areas that capital is not getting to, but by sticking to proven asset types. Many smaller and medium-sized listed UK companies just need some reform in the stock exchange and a more supportive regulatory background. The biggest challenge to industrial competitiveness is often excessive regulatory change. Suggestions that the government plans to ‘supercharge the modernisation of the UK’s financial services sector’ will create a new period of uncertainty and delay. Why must we have ‘a financial services sector ready to innovate faster’? Patient capital must be put to work in companies or projects over multiple decades, yet regulation seems to change every few years.
Amidst the package of pension fund and stockmarket reforms there is some sense. Making the stockmarket work for growing British businesses probably matters more than making it a ‘global capital for capital’, whatever that means. And a little innovation in pension funds could unlock some capital for promising industries. But any benefits will be long term and the question is whether the UK has the appetite for this patience.
The challenge in the new Westminster initiatives is that despite the immense scale of pension funds, much of what they do goes under the radar. Transparency is low, making it unlikely that there will be any public accountability for changes made. Most pension scheme savers want the best returns compatible with sustainability. There is little appetite for government direction of funds or political control.
A version of this article was published in The Herald on 8.8.2023