Budget announcement on pension charge cap
- Increasing pension charge cap for workplace pensions may not be necessary to drive pension money into long-term investments and does not overcome the major barriers.
- Plans to boost investments in infrastructure or illiquid projects should focus more on Defined Benefit schemes which hold over £2trillion rather than on Defined Contribution which hold around £200billion.
The Chancellor’s announcement of an increase in the charge cap for auto-enrolment pension schemes, above the current 0.75% level, has been well-trailed. The intention to encourage more pension money to fund future growth projects is laudable. However it is not clear to me that the Government’s proposals are the best way to achieve this objective.
Charge cap is not major barrier to illiquid long-term investments: Higher charges will dilute long-term returns for investors and risk lower pensions over time. Of course, if the investments deliver much better returns, then that will offset the charges to some degree, but the majority of workplace pensions do not even charge as much as the 0.75% cap. Indeed, the NEST schemes already invests in illiquid assets and have a charge of only around 0.3 – 0.5%. Fund managers understandably wish to charge more to manage long-term illiquid projects as the costs of overseeing and managing such investments can be higher than for mainstream market investing. However, it is not clear that the charge cap has been the main factor deterring pension funds from supporting infrastructure, housing, private equity and other potentially higher long-term return investments. Defined Contribution schemes are significantly hampered by the regulatory controls requiring daily pricing and quick transferability of workplace pension schemes if members wish to take their money out. Increasing the charge cap does nothing to resolve those problems. This has meant such pensions invest almost nothing in illiquid or long-term projects and focus almost entirely on public markets, which may not be optimal for long-term returns.
DB schemes with over £2trillion assets could do more to support long-term projects: Defined Benefit pension schemes, by contrast, have been investing in alternative assets, infrastructure, housing, private equity and other higher return funds for many years. Their trustees do not have to price the funds daily and are less constrained by liquidity concerns. The larger schemes are professionally managed and have achieved overall charges far lower than 0.75%. The Chancellor should work on plans to use far more of this money, rather than focussing heavily on modern Defined Contribution schemes in my view. Currently, those DB schemes are deterred from alternative and illiquid long-term investments because of regulatory pressure to ‘reduce risk’. In recent years, the regulatory landscape has driven trustees further away from such investments, because of fears about ‘risk’ when schemes are in deficit. Driving funds into supposedly lower risk assets, also means lower returns, which places extra burdens on employers and does not utilise the assets optimally for growth-boosting projects.
Potential for using DB assets is far greater than for DC: DB schemes are more than ten times the size of DC. I would recommend that the Government develops a state guaranteed underpin for long-term infrastructure or housing projects specifically aimed at pension schemes, which offer a guaranteed return at least equivalent to today’s yields on 20 year gilts. This would allow pension schemes to allocate far more to riskier projects that they expect to deliver higher returns, while not affecting their risk rating for regulatory purposes. The likelihood is that these projects overall would deliver far better returns than today’s ultra-low gilt yields, so the ‘guarantee’ would not cost the Treasury much, if anything, while it could bring in billions of pounds for much-needed investment. At the moment, overseas pension funds, such as US, Australia and Canada, have invested much more in infrastructure and promising smaller businesses than those in the UK. There is a clear opportunity to use more of our domestic pension asset base for growth projects than might otherwise be the case.
Raising charge cap is not really a solution: Rather than asking workers to pay more for their pension funds, we need to drive greater focus on the long-term nature of pensions and move away from the daily pricing and instant liquidity that has hindered many pension firms from investing with a truly long-term mindset.