Investment views on the Mansion House speech

What does this mean for pensions?

Private DB pension schemes came out of the reforms relatively untouched but with a clear nod that the focus will soon be on them. Consultations will begin in relation to increasing private equity allocations as well as potentially expanding the remit of the Pension Protection Fund. In addition, there was mention of plans to introduce a permanent superfund regulatory regime, aimed at creating a new scaled-up way of managing DB liabilities.

Details are fairly sparse on this so it’s a matter of watch this space, although the Government has now responded to the 2018 consultation on the “Consolidation of Defined Benefit Pension Schemes”. Given the DB pension industry is still dealing with the aftermath of the gilt crisis in 2022 the Chancellor was careful to note that this will be ‘evolution’ and not ‘revolution’ to maintain a strong gilt market.

DC pension schemes, on the other hand, are now being asked to invest in private equity. Whilst it's unfair to expect the Chancellor to delve into the nitty gritty in his short speech, that’s where the success or failure of this venture will lie. Practicalities are key, as is engaging in this topic with eyes open. Whilst the Chancellor noted this measure could increase returns, it’s equally important to recognise investment in private equity is not risk free.

Finally a consultation is being launched to examine the possibility of doubling (to 10%) Local Government Pension Schemes (LGPS) investments in private equity. In addition, directional comments that each asset pool should exceed £50 billion of assets have been made.

LGPS have a history of innovation in the private market space and have been heavier users of this asset class compared to private sector DB. As we have seen, pooling and defining what pooling means is a complex beast and the approach in the market thus far has been anything but consistent. This is not necessarily a bad thing as it can bring better ideas to the table, however this has to be balanced against achieving a better risk-reward profile for members.

Themes emerging from the reforms

“Evolution, not revolution” is the tagline being linked with these reforms, but some potentially significant changes are being set in motion. Two themes emerge from these reforms, increasing investment in the UK and increasing efficiency in the pension sector.

(i) Increasing investments in the UK

The Mansion House Compact was formally announced, where it has been agreed that nine of the UK’s largest DC pension scheme asset managers will invest at least 5% of the DC assets they manage in private (unlisted) equities, by 2030. Whilst this isn’t limited to UK equities, they’re expected to form a meaningful portion of it. This has been estimated to have the potential to plough up to £50 billion back into the economy by 2030, but the Chancellor was quick to stress that this Compact will be guided by the three golden rules:

• Firstly seeking to secure the best possible outcomes for pension savers;
• Secondly to prioritize a strong and diversified gilt market; and
• Lastly, to strengthen the UKs competitive financial center.

From a practical perspective, the Compact raises a number of questions, like the higher fees associated with private equity versus the charge cap, its traditional J-curve return profile, and its illiquidity (the historic nemesis of DC schemes facilitating member transfers). The Chancellor did hint at some of these challenges by mentioning DC consolidation as a way to ensure funds have sufficient scale to facilitate diverse portfolios and also the soon to be published consultation on a Value For Money framework, which we understand will focus on investment decisions being made on the basis of long-term returns and not simply cost.

The Chancellor mentioned the DB pension scheme surplus at a UK level. Under the bonnet, some schemes do have a larger surplus but many are still clawing back deficits. Those schemes with a surplus will no doubt be examining their end game options, with buy-ins or buy-outs with insurers being considered as well as increasing interest in alternative ways of achieving better security for members. It’s no industry secret that insurers are not fans of private equity and they can cause additional hurdles when schemes are going to market. However, Solvency II reforms could make for a friendlier environment for certain types of alternatives. The additional complexities that govern and regulate the DB pension scheme space will make the consultation in this area multifaceted and interesting.

(ii) Increasing efficiency in the pension sector

Efficiency, in the form of consolidation, has been a hot topic in the run up to these reforms, with the Canadian and Australian models being held out as role models. Their streamlined superfunds structures have the scale that brings efficiencies and lower costs, but as with most things in life, balance is key.

Larger funds can mean smaller investment opportunities are not as easily accessible, a potential conflict with the Chancellor’s target to increase investment in small UK businesses.

Consolidation in the DC space is being encouraged along with continued innovation via more collective defined contribution (CDC) funds, following tPR authorisation earlier this year of the first CDC fund set up by the Royal Mail. That being said, it is still early days for CDC, and the interplay with the mastertrust market is a developing area.

The DB pension scheme world will also likely be re-encouraged to explore the opportunities provided by superfunds following a more permanent regulatory regime being implemented. Thus far, superfunds have faced headwinds in their establishment. However, messaging from the Chancellor indicates continued Government's support for consolidation.

Lastly, on the efficiency theme, the reforms also looks to put in place a number of measures to streamline the UK capital market listing regimes, removing barriers to companies raising capital in the UK. These will assist asset managers and investors alike, so should indirectly support pension schemes.