PENSIONSANDSAVINGS.COM

• Pensions are key to reviving Britain – requiring pension schemes to invest at least 25% of new contributions in UK growth assets would boost long-term investment at no extra Exchequer cost.  
• Pension funds have abandoned UK equity markets. Restoring domestic investor support is vital to stem the outflow of good companies.  
• This is incentivsation not mandation, it uses the £70billion a year tax reliefs to help Britain, while pension managers are free to invest over 75% overseas – but without tax subsidies.  

SUMMARY: Pension funds can revive UK markets and growth at no extra cost to Government. Harnessing the power of our pension investments would help boost Britain’s economy and flagging financial markets. Requiring at least 25% of new pension contributions each year to be invested in British growth assets, in exchange for the generous tax reliefs, could incentivise pension funds to regularly invest the billions of pounds which taxpayers add to pension contributions in Britain, rather than just helping other countries.

Taxpayers provide around £70billion a year to incentivise long-term investments by British pension funds, but the money helps other countries, not Britain, weakening UK growth : Pension managers and trustees used to invest most of their assets in equities, with very high allocations to UK listed company shares. For the past 25 years or so, however, they have continuously reduced UK equity exposure. This selling has damaged Britain’s companies and financial markets, leaving UK shares undervalued, vulnerable to takeovers, less able to obtain equity finance and undermining confidence in our markets. The UK has the second largest pool of long-term investment assets in the world, but this money no longer supports the UK.

Why should the Government keep funding £70billion a year for pension fund managers to invest in other economies and not our own? Pension fund managers seem to have lost sight of the scale of taxpayer contributions they benefit from each year. £70billion is far larger than the country’s entire defence budget (around £52billion) and policing (£18billion).  How can it be good value for taxpayers, to see such huge sums invested overseas and not here?  Taxpayers should not be helping to increase pension managers’ funds under management, and facilitating overseas investment, especially when the UK urgently requires increased long-term investment to boost growth.

The Government should require pension funds that wish to receive this tax relief to invest, say, 25% of all new pension contribution into UK growth assets: This proposal can help pension managers to recognise they are managing public money, as well as private contributions from employers and workers.  Putting at least 25% of the new contribution flows – not the stock of existing assets – into UK investments would be the quid pro quo for tax relief. The funds would choose for themselves which assets to buy – including UK listed equities, private equity, start-up or scale-up businesses, real assets, housing and so on.

Several years of UK market underperformance have created a doom loop for UK equity markets and this negative spiral needs to be reversed: Pension managers cite past poor performance to justify expectations of future underperformance, leading to further selling – which is the result of past pension fund selling. UK markets and companies have been in a doom loop, becoming increasingly undervalued and vulnerable to predators, or moving overseas.

This proposal could create a virtuous circle and boost domestic investment, at no additional cost to the Government – but this is not mandation: Requiring at least, say, 25% of the money to be invested in Britain is incentivisation, not mandation. Any pension fund managers or trustees who don’t want taxpayer money added to their pension contributions, can invest 100% overseas, no problem. Currently, the vast majority of the £70billion of public spending on subsidising new pension contributions is invested to benefit other countries’ companies, assets and economies. By ensuring that there will be a regular ongoing flow of money looking to buy UK shares, pension funds can bring back liquidity, improve trading volumes, increase market ratings and start a virtuous circle of recovery for UK shares. After all, tax reliefs are supposed to incentivise long-term pension investing.

Pension fund selling is a threat to the UK’s financial strength and global standing – reversing this trend will help Government meet its growth and investment objectives: Many excellent companies in sectors including life sciences, technology, clean energy, defence, infrastructure and security, are significantly undervalued relative to overseas equivalents. Constant pension fund reductions in UK listed equity exposure have led to the FTSE markets being hollowed out, with trading volumes and liquidity drying up, IPOs reaching record lows and companies deciding to list overseas, or being bid for by foreign competitors and private equity buyers.

The UK is the only major country whose pension funds fail to overweight their own markets: Britain is a global outlier in terms of pension fund support for domestic markets: For example, the Capital Markets Industry Taskforce figures for 2023 show Australian and Italian pension funds invested around 40% in their domestic equity markets, Japan almost 50%, USA over 60% and France 26%, while UK pension funds have less than 5%. And a 2024 Report by New Financial concluded that ‘UK pensions have a lower allocation to domestic equities as a percentage of their assets, as a proportion of their total allocation to equities, and relative to the size of the local stock market than the weighted average of other pension systems’.

The situation has reached a critical point and urgent action to reverse the pension fund selling is required: So far this year, £100million of London-listed companies have been targeted by bids, including good businesses like Alphawave, Spectris and Deliveroo, while Wise has followed a string of other excellent companies which have decided to move their main listing from London to New York. Once companies are no longer listed here, the Exchequer loses tax revenues and investment that would boost the economy. While pension fund support for UK equity markets and businesses has sunk to record lows, the cost of capital for UK companies has risen and availability of start-up or scale-up capital has reduced.

Every type of UK pension scheme has drastically cut exposure to UK equities: All UK pension funds have reduced exposure to equities and increased bond allocations since the 1990s. UK pensions now have the highest allocation to bonds and lowest allocation to equities of any comparable pension system in the world. The most aggressive reductions have been specifically to UK equity allocations. Domestic institutional support for UK equity markets has drained away. Several factors drove pension funds to abandon UK shares. Traditional Defined Benefit schemes invested 32% of their assets in UK equities twenty years ago, but it is now under 2%. Local Authority Pension Schemes have cut their investments in UK equities from around 25% ten years ago, to under 9%. Defined Contribution pensions had around 40% invested in UK listed equities ten years ago, but that has fallen to around 6%. Since 2000, the share of the UK stock market owned by UK pensions and insurance companies has fallen from 39% to just 4%.  (See https://www.newfinancial.org/reports/unlocking-the-capital-in-capital-markets )

New regulatory and accounting standards encouraged risk and cost reduction, while QE side-effects accelerated equity-bond switching and increased  buyout demand: The switch from equities to bonds accelerated after the 2008 financial crisis. Initially, there was a push to encourage pension funds to ‘reduce risk’ in order to control the volatility of measured funding levels. Then monetary policy – in particular Quantitative Easing QE – vastly increased the value of ‘estimated’ pension liabilities. As QE bond purchases deliberately forced long bond yields lower, actuaries and accountants would discount future obligations by lower yields, which inflated the estimated funding obligations. This side-effect of QE was not taken seriously enough. Forecast pension deficits kept rising as QE continued for over ten years, because current asset values were compared with estimated future liabilities based on current artificially lowered bond yields. As a result of these reported deficits, employers had to plough billions into their pension schemes, rather than their businesses. Quantitative Tightening has reversed the artificially low rates, but now has the side-effect of making pension funds seem to have surpluses, as the estimated future liabilities are suddenly far lower, as higher bond yields reduce the current costs of the long-term pension payments.

This proposal would provide a radically different risk-reward equation for trustees’ assessment of their fiduciary duty. The industry, trustees and many commentators have suggested that fiduciary duty means pension funds should not be asked to invest more in the UK. They say past UK underperformance justifies very low exposure. However, the calculations of future performance would change dramatically if UK investments attracted a subsidy which other investments do not have. Investing in UK assets would immediately deliver higher overall returns, because of the additional taxpayer money which will be added to the fund as a result of investing that minimum amount in UK growth assets. That extra funding will be lost, without the domestic investment. Trustees and managers could no longer use forecasts extrapolating past UK underperformance to expect future underperformance of British assets.

The suggested 25% allocation of new pension contributions has a solid rationale: The proportion of most pension contributions originating from tax and National Insurance reliefs is significantly higher than 25%. Tax reliefs are not just tax deferred, because much of the taxpayer subsidy is never recouped in retirement. Many people receive higher rate tax relief on their pension contributions, but pay lower tax rates – and only on the marginal amounts above tax thresholds – on withdrawals. Of course, there is a 25% tax free lump sum, so this element is definitely not tax deferral – it is just tax never paid. National insurance relief is not recovered in retirement and employers also receive tax relief on their contributions. All other countries’ major pension funds have significant overweightings in their domestic markets and 25% is not out of line with them.

Rejecting this proposal could mean pension funds losing tax reliefs, as Government is seeking to reduce public spending: Ultimately, if the pensions industry keeps insisting on putting taxpayer money of this scale into mostly foreign companies, assets and markets, and rejects the idea of putting at least a quarter of new contributions into the UK, then it is hard to imagine Government retaining these generous incentives much longer.

I believe in Britain and want the country to thrive: Surely pension scheme members would generally like their contributions to help Britain’s long-term growth, especially as most people plan to spend their retirement here and should benefit from living in a better country if UK companies and markets are stronger. Pension funds could be used as the silver bullet to restore confidence in Great Britain – I hope the Government will be bold enough to do this.