Why Rachel Reeves’s pension reforms might not be as ‘radical’ as she thinks

Rachel Reeves used a powerful descriptor last night as she laid out her plot for a sweeping shake-up of the UK’s fragmented pension sector: “radical”.

The Chancellor will announce plans to consolidate the UK’s £400bn local authority pension schemes at her first Mansion House speech later tonight.

She reckons the plans could help unlock around £80bn of investment in productive investments, helping to fuel growth across the country.

While her changes may constitute the biggest overhaul of the local government pensions sector in decades, some in the City say the truly radical option for the pension industry remains firmly in the back pocket.

Reeves steered clear of suggesting that pension funds should invest more in UK stocks – and  some analysts say the plans have not gone far enough to unlock the fabled wave of investment.

“Without addressing risk appetite/ home bias (or lack of) in allocation then we will see few of the advantages being claimed,” Simon French, chief economist at Panmure Liberum, said.

Charles Hall, head of research at Peel Hunt, said the government still needed to have “initiatives to increase investment into UK equities”.

The comments reflect a growing concern in the City that the government needs to be more proactive in encouraging pension funds to invest in domestic assets.

According to research from New Financial, UK pension funds have slashed their allocation to UK equities from 53 per cent to just six per cent over the past 25 years

This has left the UK’s pension funds significantly under-invested in their domestic market compared to peers around the world.

Research commissioned by the Capital Markets Industry Taskforce (CMIT) has shown that UK pension funds are “structurally underweight” in UK markets.

CMIT’s research suggests that pension schemes in France and Italy were around 900 per cent overweight in domestic equities relative to the size of the market. In Japan, Australia and South Korea the equivalent figure stands between 1,000-3,000 per cent.

In the UK, by contrast, the largest funds were 40 per cent underweight relative to the size of the market. This is less pronounced in public sector pensions, where the UK is “firmly in the middle of the pack”, New Financial said.

The withdrawal of domestic capital has come amid a globalisation in the pension fund market as fund managers more easily channel capital overseas into foreign stocks.

Tax tweaks ushered in by Gordon Brown also scrapped a dividend relief for domestic pension funds, triggering a flight away from stocks and toward the bond markets.

Forcing pension funds to back Britain is seen as a controversial option, and critics point out they have a fiduciary duty to their members and not the health of London’s ailing stock market.

But Julia Hoggett, boss of the London Stock Exchange, said this week the withdrawal of domestic capital from UK equity markets had created a “lovely self-referential logic”.

“As you strip money out of a market, the risk is it doesn’t perform as impressively, and then it becomes the justification for continuing to strip money out of the market,” she said.

Little by little, the government has been inching towards encouraging pension funds to back domestic markets.

The Mansion House compact has on paper committed to 11 of the top pension money managers to invest five per cent of their assets to private companies by 2030. In March this year, then Chancellor Jeremy Hunt threatened “further action” against firms who didn’t up their allocation.

Nicholas Lyons, former Lord Mayor of London and chair of the UK’s biggest retirement firm Phoenix, said mandation was at its “most powerful when it’s kept in the back pocket”.

He argued that requiring greater pension funds to have greater transparency about their asset allocation would likely make a big difference on its own.

“Once people start having to be transparent about what they do, they tend to sort of read the writing on the wall,” he said.

The more palatable route may be cutting taxes like a stamp duty on shares and dividend taxes in order to incentive pension funds back into British companies. A similar system has been adopted in Australia, where pension funds have the second highest domestic equity allocation in the world.

However, for the time being Reeves has opted to bet on the approach of consolidation. It appears that the truly ‘radical’ option will remain in the back pocket – for now.

A Treasury spokesperson said: “These announcements do not include mandating investments, instead they are aimed at enabling funds to invest in a wider range of assets which will in turn benefit the UK.”