Chancellor Jeremy Hunt’s plan to enable UK pension schemes to invest in a broader range of assets will transform the investment role of DB pension funds.
In his Mansion House speech, Hunt said the changes are aimed at both boosting the investment returns available to pensioners and driving capital into early-stage and unlisted companies,
He said nine pension providers signed up to a voluntary “compact”, whereby they agreed to have a 5 per cent allocation to those assets as the default. That could equate to around £75bn of assets.
In a Work and Pensions committee hearing today (September 6) on DB pension schemes, Brian Denyer, senior solutions director – pensions at Abrdn, said the announcements will change the way in which schemes could invest.
Denyer explained that the speech has fueled debate within the industry about offering pension schemes choice around what their long term funding target is.
“At the moment, what we have within the pension industry is most schemes are moving on a journey to a pathway to insurance buy-out as soon as possible,” he said.
“This means that in terms of their investment strategy - derisking through time into an investment strategy - at the point of buyout will largely be gilts and investment grade credit so this means reducing equity allocation.
“Today, most pension schemes invest their equity allocation globally, on a passive basis, which means even if it's a small equity allocation, it’s a much smaller investment in UK equities.”
He explained that because funding levels have much improved from the events over the past 18 months, there are schemes which are much closer to buy out now than they were previously.
“This means that we're seeing much less investment in illiquid assets, the sorts of assets that we really need to be invested in for that transition to net zero and our economy,” he said.
“That's where we are today. What Mansion House does is open the debate around whether we can give schemes more choice. So that choice might be let's delay buy out for a period of time. Or maybe we run off indefinitely.
“But if we have delayed insurance buy out, or if we have schemes running on for longer and potentially derisking, then we could increase that equity investment, also in length and investment time horizons, which means that creates liquidity requirements in short term, and it could potentially feed greater investment in illiquid assets.”
Meanwhile, Serkan Bektas, head of client solutions group at Insight Investment, said UK DB pension schemes already play a key role in the investment economy and in productive finance, but he believes this role can be enhanced further.
“Pension schemes investments in gilts supported the UK through a period of heavy gilt issuance and pension schemes investments in bonds and other fixed income assets provide essential funding for corporates and the economy overall.
“Having said that, we've now had a once in a generation opportunity to enhance this role further. We support the three golden rules of the Mansion House speech and believe DB pension schemes are extremely well placed to support those goals, subject to the establishment of the right framework.”
He explained that pension schemes have surpluses, and they have the ability to grow those surpluses without putting the security of pension plan members at risk and that is the key to unlocking some of the opportunities.
“First of all, it's important that as pension funds evolve, they do not return to deficits,” he added.
“This requires them to continue to match liabilities and ensure member securities are preserved - then, excess surpluses can be deployed over investments and due to the size of the DB pension industry, these surpluses can be very material and can have a very positive impact on the UK economy overall.”
Considering the differences between pension funds and insurers, Bektas said pension funds have some unique advantages as they can access a broad investment universe beyond what is an efficient insurance space and through that, construct portfolios that defeat their liabilities cheaper than the cost of buyout.
“The result and savings is of tangible value to members and corporate sponsors,” he said.
“Secondly, pension funds are uniquely placed to pursue surpluses for the benefit of their members.
“Buyout transactions and other solutions tend to focus on contractual liabilities with limited scope to make payments beyond those contractual liabilities.
“If pension funds are able to successfully pursue surpluses, they can benefit DB pension plan members, they can benefit corporate sponsors subject to the establishment of the right framework.”
He argued that this framework requires pension funds to be encouraged to revisit the benefits of running on.
“When timeframes are short, the ability to invest for the long term and take risk will be adversely impacted,” he added.
sonia.rach@ft.com
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