In Rachel Reeves’s Mansion House speech, she has unveiled her plans to consolidate the 86 funds of the Local Government Pension Scheme (LGPS) into a small number of “mega-funds”.
There has already been some consolidation under previous administrations, but this plan is more radical. The Chancellor is planning to create these large funds which she claims will not only deliver better returns, but also allow a large pot of the money – she estimates £80bn – to be invested in green and tech infrastructure. This would represent 22 per cent of the latest value of £361bn of assets currently in LGPS.
However the LGPS is not actually a fragmented scheme; it is already one scheme, with all the benefits to workers and pensioners guaranteed by central government. This is unlike private funded schemes, whose benefits to pensioners are not guaranteed by the government, and which are genuinely fragmented.
LGPS has so many separate funds managed by local authorities as a matter of history and localism. In the past, Councils have felt proprietorial towards “their” pension funds, and have resisted giving them up to larger groupings.
But although these funds are locally managed by the Councils that set them up and funded them through their employees’ and employers’ contributions, they do not actually form the basis of the pensions promise. The funds themselves simply provide an offset to the Government’s guarantee.
However, having (partially) funded schemes – even ones guaranteed by Government – is better than fully unfunded schemes, where the cost is borne by people two generations younger than the beneficiaries. LGPS represents a relatively small part of the overall Governmental pensions promise; which is dominated by the completely unfunded central Government employees’ pension schemes.
The Government’s claims that very large size in pension funds (£25bn-£50bn) improves returns is not borne out by the international evidence, except to the extent that some reduction in professional investment fees can be achieved in very large funds. It is true that infrastructure projects are often very large scale, but many are already securitised, or formed into funds, allowing smaller but still institutional investment size to participate.
The tone of the Mansion House speech implies that the Government will be directing or “encouraging” investment into its pet projects, like green and tech infrastructure.
These are very high risk, long-term and illiquid investments. Many pension funds are reluctant to risk their money on these sorts of investments given that there is already a huge universe of attractive domestic and international investments (like listed equities) currently available to them.
However, most problematic is the idea that the Government’s political agenda should determine investment choice. The remit given to the professional investment managers that currently manage LGPS funds is that they (a) stick to their area of expertise and investment guidelines, and (b) that they maximise the return/risk ratio for their chosen asset class.
The Chancellor may believe that £80bn can be productively invested in green and tech projects; but it seems likely that her incentive is primarily to promote her political agenda. By contrast, the investment professionals may or may not choose to invest in infrastructure.
Sophisticated investment techniques for pension funds such as asset/liability modelling have already been developed to include all relevant asset classes – including infrastructure – in judging what asset-class weights are needed for an efficient and well-diversified portfolio.
Adding in Mrs Reeves’ views are unlikely to improve their performance.
The Chancellor’s belief that her ‘directing’ funds into UK infrastructure investment will promote economic growth is also misplaced. Whole-economy growth requires sustained improvement in the labour productivity of the working population, as well as maintaining constant or rising levels of workforce participation.
According to the latest figures from the Office of National Statistics (ONS), the construction sector has below-UK-average levels of labour productivity, so the work itself will not make us richer. Indeed, if construction itself forms a more substantial part of the economy, it may make us poorer.
Whether or not the increased physical capital that results from construction makes us richer depends on the extent to which it improves economic performance in the area to which it is applied.
Obvious examples of productivity-improving physical capital investment include modern automated and robot production facilities, making the same or more products with a smaller or much smaller workforce.
By contrast “green” infrastructure (wind farms; solar; nuclear) is heavily subsidised in the UK, otherwise less would be built. Measured against international market energy prices, the energy they produce, carry or store is very expensive, increasing the cost of energy for the general population, making them worse off. This is the opposite of economic growth.
So not only is the Chancellor creating new and potentially dangerous conflict of interest in the pensions market, she may also be shooting herself in the foot from a growth perspective.