Workplace pensions to invest billions in unlisted stocks

The government has outlined an intervention in the allocation of the UK's trillions of pounds of pension holdings, after Chancellor of the Exchequer Jeremy Hunt announced that nine of the largest defined contribution (DC) pension schemes had agreed to allocate at least 5 per cent of their default funds to unlisted companies by 2030.

Aviva (AV.), Scottish Widows, Legal & General (LGEN), Aegon, Phoenix (PHNX), Nest, Smart Pension, M&G (MNG) and Mercers have signed the Mansion House Compact, Hunt said, covering over two-thirds of the UK DC workplace pensions. 

Speaking at Mansion House on Monday night, Hunt said that this and a number of other measures could reverse the "perverse situation" where overseas investors were backing growth-focused companies more than UK institutional investors. Higher-risk allocations could add over £1,000 a year to an average earner's retirement income, the chancellor said. 

The other goal is to add £50bn of investment into unlisted companies by 2030, which is dependent on the rest of the UK DC pension market following suit. The sector has become a focus as the government seeks to tackle a lack of major tech and biotech success stories and weak IPO pipeline, as even homegrown companies such as Arm choose New York over London as a listing venue. 

But how much will actually be invested in British companies remains to be seen. The agreement signed by the DC schemes does not include any commitments to invest the money in the UK. The document only mentions “a desire” to invest in the next generation of UK scale-ups “as part of a diversified portfolio”. 

Existing private equity allocations will count towards the target, reducing the amount of new money involved. Nest, for example, had already set a target to invest 5 per cent of its assets in private equity in 2022, and its exposure to the asset class stood at 1.5 per cent as of March 2023. Schroders Capital, which handles part of Nest’s private equity allocation, was tasked to source deals in North America, Asia and Europe (including the UK) when it was awarded the contract.

Adrian Gosden, investment director at Gam Investments, pointed out that the reforms do not address the fact that the UK listed market has become less attractive. “What the chancellor should focus on is encouraging UK asset owners to invest in already listed mid- and small-cap UK companies,” he said.

Hunt also announced measures that could see DC schemes wound up on the basis of underperformance: the government said that over a five-year period there can be as much as 46 per cent difference between the best and worst performing pension schemes, meaning that a saver with a pot of £10,000 could have notionally lost £5,000 over a five-year period from being in a lowest performing scheme.

Alongside this plan, the chancellor briefly outlined a programme of "DC consolidation, to ensure that funds are able to maintain a diverse portfolio of bonds, equity and unlisted assets and deliver the best possible returns for savers". He said defined benefit (DB) schemes would also be looked at for consolidation options, and promised a "permanent superfund regulatory regime to provide sponsoring employers and trustees with a new way of managing DB liabilities". He alluded to the gilt crisis last year, driven by Liz Truss' and Kwasi Kwarteng's mini-Budget, by adding that the government would "prioritise a strong and diversified gilt market". 

The prospect of investing pension funds in higher risk assets has caused some concern, with savers stung in the past by unlisted assets. The chancellor said that in “everything we do we will seek to secure the best possible outcomes for pension savers, with any changes to investment structures putting their needs first and foremost.” 

AJ Bell head of retirement research Tom Selby said the reforms had sensibly been kept "away from the retail investment world, where illiquid investments are more likely to be problematic". He said the claim of savers being £1,000 better-off was optimistic. "It is, of course, possible that an investment approach that embraces a bit more risk over the long-term will ultimately boost member returns – but there are absolutely no guarantees," he added. 

Jason Hollands​​​​, managing director at Bestinvest, added: “It is hard to imagine that a financial services company would get away with making such an unequivocal statement about future returns, which are inherently uncertain.”

The government will also consult on accelerating consolidation of Local Government Pension Scheme (LGPS) assets, with the aim of transferring all their assets into local government pension pools of at least £50bn in size by March 2025. It will also consult on doubling existing LGPS allocations to private equity to 10 per cent, which could channel up to £25bn into this asset class by 2030.

LGPS funds already have significant exposures to alternative assets, including within real estate and infrastructure. As with DC funds, their existing private equity investments are not exclusively UK-focused. 

 Philip Pearson, partner at pension consultancy Hymans Robertson, said that private equity is already “playing a big role” in their portfolios and that the firm generally recommends investing via global private equity mandates “as this typically leads to superior investment outcomes” - although he added that a dedicated allocation to UK companies could also have a part to play and be a source of opportunities.

The details of the reforms are due to be finalised ahead of the Autumn Statement in November.

Alongside the DB and DC scheme upheaval, the government has published draft legislation on listing rules which aims to enable companies to raise larger sums from investors more quickly. And by the end of 2024 it will set up an “intermittent trading venue” which will improve private companies’ access to capital before they publicly list.

Meanwhile, the Department for Work and Pensions is to consult on how to consolidate small pension pots that have proliferated, amid the rise of auto-enrolment, as workers move from one job to another. Auto-enrolment itself is also being expanded, via changes that include the lowering of the minimum eligible age from 22 to 18.