Rachel Reeves wants more pension schemes to invest in UK private assets. Can she succeed?

What are the challenges facing the chancellor and are British pension schemes really are laggards compared to Canadian ones, when it comes to investing in private assets?

It is coming up to one year since UK chancellor Rachel Reeves unveiled a raft of reforms to the UK’s pensions landscape, each one with the same goal in mind: growing the UK economy. 

As these reforms have taken shape, the party line of the Local Government Pension Scheme has often been that it is ‘not here to grow the UK economy. It’s here to pay pensions’. The Labour government seems to be asking the LGPS why it cannot do both.

In theory, there’s nothing wrong with killing two birds with one stone. But markets are complex. The strategy for financial success this year, or this quarter, sometimes changes in an instant. This presents more than a few problems when a government attempts to legislate on how large asset owners invest.

Accessing private markets

In April, Labour instructed the existing eight pension pools to consolidate into six, which is on track to happen this month. The reasoning behind this? More assets under management will mean the LGPS can pump more capital into private markets.

A voluntary Mansion House accord has already been signed with this in mind, with 17 pension providers pledging to allocate at least 10 per cent of defined contribution default funds to private markets by 2030.

Reeves views Canada as an example of the way forward, where large pension schemes such as the Caisse de dépôt et placement du Québec take chunky stakes in private companies.

And it certainly is true that Canadian pension schemes which have exposure to private equity tend to have much larger exposures than UK pension schemes with exposure to private equity - but not by as much as you might think.

The Canadian average is a little over 10 per cent while the UK average is 8 per cent - though it is certainly true there is a greater proliferation of Canadian schemes with chunky exposures.

About 12 per cent of Canadian schemes with an exposure to private equity have one above 20 per cent. For UK schemes the proportion is 4 per cent.

On the one hand, jumping on the private markets bandwagon may seem a sound investment decision. Private equity and private credit can both offer higher returns. As a result, the asset class has grown exponentially in the past decade.

Consultants at Bain and Company predicted last year that private market assets under management would increase at more than twice the rate of public assets to reach as much as $65tn by 2032.

There is also an increasingly large number of vehicles to give investors access to private markets, including private assets ETFs.

But this is not the entire picture. Data from Preqin suggests the growth in private equity assets under management has slowed down. Although private equity groups raised $592bn in the 12 months to June, this was the lowest tally for seven years.

McKinsey agreed fundraising this year had been “tough”, with investment returns for private markets remaining “muted, especially compared with buoyant public markets”. This has been attributed, at least in part, to a delay in IPOs.

Keith Onslow, chair of the London Borough of Bromley Pension Fund, told AOX there has been little to entice the scheme into investing in the asset class so far: “Private equity is, very often, highly geared, and this works quite well when interest rates are low, but when interest rates are high, which I think you could argue they are at the moment, is it worth the risk? I have my doubts about that.”

Onslow continued: “We’ve got an asset allocation review, which is due to complete on December 2. I have asked for some comments about private equity investment but, honestly, I’m not seeing anything come back at the moment that excites me.”

At the very least, this threatens to throw cold water on the government’s determined optimism.

Mandating local investment

The other part of these reforms raises further issues for the LGPS. At her second Mansion House speech earlier this year Reeves stressed the importance of channelling more UK pension fund capital into domestic investments in infrastructure, clean energy, technology and life sciences.

Perhaps most controversially, the government plans to retain a backstop power to force large pension funds to back British assets, with a new pensions scheme bill giving ministers the reserve power to set binding asset allocations.

But the danger with forcing the LGPS to invest locally is that it may not deliver financial returns, particularly in a country where the FTSE 100 index is biased heavily towards very unsexy sectors like banks, financial services and mining companies.

The FTSE 100 has returned about 50 per cent over the past five years while the S&P 500 has returned nearly 100 per cent - and the amount of money raised by IPO on the London Stock Exchange has fallen to a 30-year low.

Questions have already been raised about whether requiring local investment could undermine the LGPS’s fiduciary duty to its savers.

Trade body Pensions UK said it “believes in a pensions sector that puts fiduciary duty to savers at its heart, with free and open market competition to drive better outcomes for savers".

It went on to add: "We believe that the best way of ensuring good returns for members is for investments to be undertaken on a voluntary, not a mandatory basis."

Onslow said that if investments were to be ‘local’ then he would want them to be properly local, arguing he would want “Bromley money being used in Bromley borough”.

He added: “I can’t really justify using pension fund money from Bromley to build, for example, some social housing in another London borough. If another London borough wants to build some social housing in Bromley and house Bromley’s homeless people, then that's their choice. But I rather think they're going to look after themselves in the same way as we would.”

There is also the question of whether allowing the government to dictate the investment strategy for pension funds will make it difficult to determine who holds ultimate responsibility for the financial returns of the LGPS.

Alison Leslie, head of DC investment services at Hymans Robertson, said she was "not a fan of mandation". She added: “The question is, if you do mandate it and the returns do fall short, where does the responsibility lie?”