Labour’s pension reforms are based on flawed analysis
Rachel Reeves The speech of the mansion He was not short of ambition last November, promising “the biggest pension reform in decades”, and two public consultations on what this means in practice end in a few days.
As part of his “investment, investment, investment” mantra to boost growth, the chancellor’s autumn budget announced £100bn of capital spending over the next five years. To top it off, Reeves wants to merge pension funds into “mega-funds”, not to spook the gilts. which then invest more in UK “private assets” – venture capital and infrastructure.
This ‘enlargement’ applies to both the £400bn defined benefit scheme for local government staff in England and Wales (excluding the £60bn local government scheme in Scotland) and defined contribution (DC) pensions for private sector workers also wants DC retirement savers keep more in UK stocks.
Political rhetoric aside, these “reforms” appear to be based on flawed and flawed analysis.
For DC workplace pension funds, the government wants a minimum size of £25bn and preferably up to £50bn, with fewer ‘default’ investment options.Notably, changes will not take place until 2030, after the next general election.
The UK currently has around 30 ‘master trusts’ authorized by the Pensions Regulator and a further 30 ‘contract’ providers with total assets of £480bn.
DC pensions certainly need a minimum asset size to spread fixed costs and encourage good governance, but the government’s analysis of why the threshold should be up to £25 billion is weak, and its comments on Canadian and Australian pensions are selective or irrelevant :
For example, all of Canada’s Maple 8 pensions, which Reeves is very interested in, are either public sector defined benefit schemes, including Ontario’s three schemes for teachers, medical staff and local governments, or they fund Canada’s public pensions. so say us nothing about UK DC pensions.
And yes, Australia’s DC “super funds” are larger in absolute terms than UK DC pensions, but they run much longer and have much higher annual payouts (while the UK Govt. delay review raising auto-enrolment minimums.) But Australia is also much less concentrated than the UK, with the top 10 largest schemes having a much smaller proportion of total assets than the UK.
What do DC savers get out of investing in the UK, apart from a patriotic glow like buying war bonds?
Analysis by the Department of Government Actuaries, published in support of the Mansion House speech, is not encouraging. It concludes that the potential risk-adjusted returns for DC savers if they switch to international shares, particularly US, UK shares and private assets, are almost the same, any difference in 30 years of regular savings is lost during rounding.
Since the potential returns are identical, DC savers should make their investment decisions on a second-order basis of maximizing international diversification and minimizing costs.
UK stocks represent 4 percent of the MSCI World Index; US stocks, dominated by large tech companies, account for 70 per cent, but the UK equity allocation to DC pensions is already 8 per cent, a double ‘neutral’ weighting.
There are good reasons for UK investors to be overweight in the UK. lower management charges and costs, no need to hedge currency against sterling, and many British companies operate overseas, providing some international diversification anyway.
The chancellor could always tip the scales and subsidize UK shares by reinstating the dividend tax credit, which was abolished by earlier Labor chancellor Gordon Brown in 1997. The Australian dividend tax credit appears to be the main reason Australian savers are holding Australian shares. It would certainly be more expensive to do this in the UK, and certainly better tax-wise to give benefits to companies investing directly in their business.
As for keeping management costs to a minimum, fees for UK private assets are much higher than for public, passive equity tracks. Adding insult to injury, performance fees, which are paid in addition to annual fees, are excluded from the 0.75 per cent self-registration fee cap. :
Meanwhile, new pensions minister Emma Reynolds has also given us a hard time warning that “the government can force pension funds to invest more in UK assets.” He does not explain how this might work in practice, however, given the statutory and common law fiduciary duties of pension trustees to act in the “best interests” of their members.
He hinted that the government could reduce tax breaks for overseas investment, certain to undermine confidence in pension savings, which are fragile at the best of times.
Over the years, various foreign governments have tried to dictate how pensions should be invested, and none have gone well.
John Ralph is an independent pension consultant. @johnralfe1:
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