The drift away from free market globalisation as a dominant idea has led to increased calls for pension funds to invest domestically
In his exclusive column for Professional Pensions, Gregg McClymont says that, in taking a backstop power to direct investment, the UK government has done something all but unthinkable just a decade ago.
News that the forthcoming Pensions Bill will include a backstop "direction of investment" power marks a significant escalation in the government's campaign to deliver more domestic investment.
The existence of this backstop power has somewhat overshadowed the signing of Mansion House II by 17 funds and providers this morning (13 May), with its pledge to a 5% allocation to UK private markets (including infrastructure) by 2030. But of course, they are intimately connected – the former being the means by which government maintains pressure on schemes to deliver the Mansion House Accord.
How did we get here? A decade ago, the notion of politicians directing pension fund investment decisions would have been fanciful. Even as George Osborne set about after the 2015 election to scale up the Local Government Pension Scheme (LGPS), the focus was on reducing investments costs rather than on increasing domestic investment.
On the other hand, the potential for a connection was there in theory at least: the same chancellor had previously set out a plan for ‘£20bn in UK pension fund investment in infrastructure', an initiative which encouraged the creation of the now defunct Pensions Infrastructure Platform (PIP), which was owned by, and invested on behalf of, five UK schemes.
As in so many other policy areas, Brexit has a role to play, because it exacerbated existing UK economic weakness, significantly depressing GDP according to all reasonable estimates.
More specifically with Brexit, UK access to the European Investment Bank (EIB) and the European Bank of Reconstruction and Development (EBRD) ended – these institutions were a significant source of infrastructure project structuring expertise and the EIB's case a significant source of finance too (c.€5bn per annum in the UK's case), which has not been adequately replaced.
After 2016, as the UK's productivity failures became starkly apparent, the search for growth solutions intensified. If persistently low levels of investment both public and private had long been identified as a weakness in the UK economy, a specific problem was identified by policy makers with respect to domestic investment in ‘high growth', that is, potentially high growth, companies often located in the bio sciences and digital technology sectors.
The argument here is and was simple: too much of the value created by new UK companies is captured by US investors in particular who, deploying the scale and expertise of its venture capital sector, buy up these enterprises. If, and when, they succeed, the rewards often end up in the US (and usually the companies too).
But it is also an argument in tune with the backlash against the ideology of globalisation which until recently was the UK's governing orthodoxy, set out most bluntly by Tony Blair twenty years ago now: "I hear people say we have to stop and debate globalisation… You might as well debate whether autumn should follow summer".
Free markets were the corollary of globalisation – economic actors should pursue their own objectives and in doing so all would benefit, in aggregate. With Trump's first victory and Brexit, both in 2016, these assumptions for the first time since the 1970s faced significant challenge from new forms of nationalism which focused on the distributional consequences of what was often known as "the Washington consensus".
The international experience
Pension funds have increasingly been caught in these currents, their duty to prioritise members financial interests having led to a globally diversified asset allocation. This becomes obvious when one looks beyond the UK's shores to the systems which the current government has cited as the major inspiration for its proposed LGPS and defined contribution (DC) reforms, respectively.
In Australia, the undoubted success of superannuation in creating a large pool of capital for investment, and, in particular, its significant domestic bias in public and private market allocations – a product of tax incentives and the privatisation of local infrastructure at the very moment the super funds were on the hunt for these assets – has not prevented politicians from demanding more domestic investment.
Such calls have come especially to solve Australian's housing supply crisis, whether via pension funds financing new construction, or pension members being able to access their pot to raise mortgage finance. The Australians call it "Nation Building" with the Treasurer (equivalent of UK Chancellor) hosting a series of summits with funds to discuss how to finance national priorities.
In Canada, the pressure on the Maple 8 funds has been – rhetorically, at least – even greater, reflecting the fact that their domestic allocations at around 20% are lower than the Australians at around 35%.
The Maple 8 pioneered a global public and private markets approach to pension funds, this, as well as the fact that Canadian infrastructure is largely owned by provincial governments rather than by the private sector, explains their relatively lower domestic bias versus Australia.
While this might be prudent as a matter of strategic asset allocation, it has led to increasing criticism from within Canada, where stretched public budgets struggle to finance new infrastructure at the required scale, and where the Canadian stock market is seen to require greater domestic financing (not least in the light of curbs on Chinese investment).
This of course is also the case in the UK, where the practical requirement of ministers looking to the immediate future is to find domestic sources of savings for capital investment across the economy public and private, and ranging growth equity through to infrastructure. Furthermore, the domestic bias in UK pension fund allocations is on average less than in Australia or Canada, because of the huge role that global indexed equities have played in the average default fund and also (versus the Australians at least) because of the modest domestic infrastructure allocations by UK funds.
But the wider context in which urging pension funds to act patriotically has become politically plausible – across parties – is the drift away from free market globalisation as a dominant idea. The Great Financial Crash and the subsequent fiscal crises, Trump, migration crises, and Brexit have one way or another, all contributed to this developing perspective, in the UK and elsewhere.
In taking a backstop power to direct investment, the UK government has done something all but unthinkable just a decade ago.
Gregg McClymont is executive director of public affairs at IFM Investors and a former shadow pensions minister
