How Rachel Reeves can unlock billions from pension funds

Ros Deegan stands on the brink of a major breakthrough. Clinical trials are set to begin on new medicines developed by her venture, OMass Therapeutics, that target an adrenal disorder, among other things.
If the medicines work they will immeasurably improve the lives of sufferers — and set OMass, an Oxford university spin-out, on course for a major windfall.
However, not all the profits will stay here, as some of her recent investors have come from the US. Deegan, 51, would like pension funds to contribute to the next round of funding for OMass, but knows they tend to invest their capital in lower-risk assets, such as government bonds and acknowledged: “There is a significant probability that, given the scale of investment I will need, my new capital is likely to come from the US.”
The chancellor, Rachel Reeves, is now targeting a shake-up of Britain’s pension fund industry that could mean that, in future, Deegan gets her wish. On Thursday, in her maiden Mansion House speech, Reeves will tell City bankers she wants the £2.5 trillion held in Britain’s pension funds to be invested in Britain — not just in start-ups such as Deegan’s, but in the major infrastructure projects that are needed to drive economic growth.
A Treasury spokesperson said pension reform was key to the chancellor’s economic plans and would be set out in the Mansion House speech. “This will unlock more private investment to fuel the government’s growth mission,” they said.Pension funds have cut the proportion they invest in UK equities from 53 per cent to just 6 per cent over the past 20 years. Blame for this has been pinned on a regulatory clampdown on pension funds aimed at taking risks out of the system after scandals in the 1990s.Yet any measures by Reeves to force pension funds to invest more in UK stocks risk stoking a backlash. Research in today’s Money section finds that funds that invested in Britain over the past five years have performed worse than those that invested elsewhere. And there will also be concerns about pension funds taking too much risk.
Nevertheless, pension reform is firmly on the agenda as the chancellor seeks to shift the public narrative back to economic growth, after burdening businesses with higher taxes in last month’s budget. So, how could Reeves shake up Britain’s pension industry?
There are £360 billion of funds sitting in the UK’s 87 local authority pension schemes, which manage the retirement savings of six million people. If the schemes were run together, they would be the world’s seventh-largest pension scheme.
Reeves is interested in so-called Canadian-style reform of these schemes to more effectively put this capital to work. Canada has pooled together the funds of eight pension schemes — known as the Maple 8 — which now collectively manage more than £1 trillion of assets.
The logic goes that bigger pools of funds can better manage the risks of investing in riskier assets, thereby boosting returns. They will also save £2 billion in fees each year, because larger funds can extract better deals from advisers.
It is not the first time this has been on the agenda. In 2015, then chancellor George Osborne announced a voluntary system for local authority pension schemes to merge. Eight pools were set up, but less than half the schemes joined.
Reeves has expressed frustration at the limited uptake. In July, just days after Labour won the election, she led a review of pensions that raised the prospect of introducing legislation next year to force local authority schemes to merge.
The Pension Insurance Corporation (PIC) will publish research this week showing that if local authority schemes merged into pools of £100 billion each, it would unlock more than £200 billion to invest into major infrastructure.
Tracy Blackwell, chief executive of PIC, which manages £47 billion of pension fund money, reckons that if local authorities act as initial investors in major projects then private investors will follow. Her calculations are based on each £100 billion fund investing £14 billion in infrastructure and “crowding-in” £42 billion from private investors.
Others in the sector believe local authority pension fund money can also be put to work alongside government funding. They point to the £7.3 billion National Wealth Fund — formerly known as the UK Infrastructure Bank — which aims to attract £3 of private capital for every £1 invested by the government, and argue that the onus is on the government to provide details about the projects that pension funds should back.
In her pensions review in July, Reeves also raised the prospect of merging defined contribution (DC) schemes, which have become the standard scheme offered in the private sector. There are an estimated 27,000 such schemes, most with fewer than 12 members, having sprung up as a result of the introduction of auto-enrolment in 2012, which required employers to enrol staff in pension schemes and make contributions to their savings.According to the government’s estimates, these DC schemes will hold more than £800 billion by the end of the decade. While the details of any scheme mergers are unclear, in broad terms Reeves wants to get these funds to shift out of less risky assets — such as government bonds — and into so-called productive assets, such as infrastructure. Labour’s review calculated that if just 1 per cent of DC scheme funds could be invested in riskier assets, £8 billion of fresh investment could be unleashed.
Some see this as an attempt to replicate Australia’s co-called superannuation funds, created in the 1980s to pay for workers’ retirements, which have been lauded for making bold investments both at home and overseas.
Reeves is expected to tackle another issue in a second phase of her review: how much people are saving. Andy Curran, who runs the Standard Life pension business at the FTSE 100 insurer Phoenix, reckons auto-enrolment should start to be raised from 8 per cent of salary, paid by employees and employers, to 12 per cent, to give people more adequate pensions at retirement.
If any change is made it is likely to be done so gradually, to soften any additional burden on businesses.
Another £1.7 trillion sits in defined-benefit pension schemes, which pay out based on salary and length of service, and are now largely closed to new members. The previous government set up a framework to create “super funds”, although progress on consolidation has again been slow.
These schemes are being targeted for “buyouts” by insurance companies, which effectively take over the management of the funds. This is particularly true for the defined-benefit schemes sitting on surpluses. The total of these surpluses is estimated at about £225 billion.
Some in the industry are campaigning for schemes in surplus to be permitted to invest more capital in riskier assets — such as the stock market or infrastructure — or even to return funds to the companies that run the schemes. This would need strict regulation to shield pensioners from losses if the schemes were to fall into deficit in future.
“There is a massive opportunity for the government to unlock that massive pot of money and get that working more for members, sponsor companies and the UK,” said Steve Hodder, partner at the consultancy Lane Clark & Peacock.
Attendees at this week’s Mansion House dinner could be forgiven for feeling a sense of déja-vu. At last year’s event, Reeves’s predecessor in No 11, Jeremy Hunt, pledged to unleash investment from pension funds and explore how to merge schemes.
Hunt’s measures included the historic Mansion House Compact, devised by then lord mayor of London, Sir Nicholas Lyons, under which the biggest firms managing defined-contribution schemes agreed to allocate 5 per cent of their investments to unlisted equities, such as biotech start-ups, by 2030.
Still, those hoping for swift progress have been frustrated. Even Phoenix, where Lyons is chairman, has only just signed a deal with the asset manager Schroders to create a “future growth fund”, with an aim of investing £2.5 billion over the next three years.
The new lord mayor, fund manager Alastair King, who took over last Friday, intends to “refresh” the compact and bring forward the 2030 target date. “The question mark is: do we need to speed it up? I think that might be something we look at,” he said, adding that he believed a further “iteration” of the compact could include investing in companies listed on the stock market.
With access to more capital, Britain’s fast-growing companies can invest more, create more jobs and, potentially, one day float on the London Stock Exchange.
In 2019, Deegan, the biotech entrepreneur, helped to float Bicycle Therapeutics, a British business, on the New York Stock Exchange. She suggests that if British pension funds were xx the main xx investors in companies such as hers, rather than overseas investors, it might make it harder for them to defect. “Growth capital from the UK keeps companies sticky. It means there’s less pressure on them to move to the US,” Deegan said.
Reeves can see the prize of revolutionising Britain’s pension industry. This week, she needs to convince the City she can grasp it.