Pensions World

UK pension funds have suffered serious damage from recent policies to stimulate growth – in particular low interest rates coupled with quantitative easing (QE) have led to significant increases in pension liabilities, which have been further compounded by the sharp rise in inflation in recent years.  As their liabilities grow, so do their deficits and funds have been trying to reduce risk by investing in bonds, but bonds cannot overcome the deficits.

Billions of pounds of pension fund assets are languishing in gilts or being invested in commodities, hedge funds and even infrastructure funds (many of which invest largely in overseas infrastructure rather than the UK), whereas investing directly in UK infrastructure projects could be a huge benefit to both the funds themselves and to the economy.

Given that government policy itself has so badly damaged pensions, and given that public sector (local authority) pension funds are desperately in need of better returns, coupled with the fact that the government needs to stimulate the economy and UK infrastructure urgently requires modernisation, it seems only sensible that we should harness the power of pension fund assets to boost long-term growth potential and boost pension fund returns.

Local authority pension schemes are in serious deficit and, if they cannot return to full funding, the government would have to bale them out anyway.  Recent estimates suggest that there is a shortfall of around £60bn in local authority pension funds, with assets of around £140bn, so they clearly need extra returns to help bridge this gap.  Therefore, it makes much more sense for the government to help these pension funds invest in domestic infrastructure projects, which will generate potentially higher returns and better income than conventional assets such as gilts or other bonds while also helping long-term domestic economic growth.  This could be a win-win for all.

Given that the government would have to underpin local authority pension deficits anyway, it even makes sense for the government to incentivise public pension funds to provide billions of pounds for infrastructure investing.  Incentives could include underwriting an inflation-linked income stream in the future, which would provide comfort for pension trustees that this money would at least perform like long-term inflation-linked gilts (which are currently in such seriously short supply).

Investing in infrastructure can offer an ideal type of return profile for pension funds - especially if the returns are underwritten by the government.  Indeed, local authority pension funds already invest an average of 1% of their assets in infrastructure funds, but using funds incurs higher charges (and therefore lowers potential returns) as well as investing overseas rather than just in the UK, thereby meaning they will not be helping just UK long-term growth.  By helping pension funds invest directly in infrastructure projects (obviously managed by experienced companies!) and also underwriting some of the long-run returns for them, they will be better able to help their own funding position as well as the UK economy.  And if this investment stream does help growth and reduce the fiscal deficit, it will be far cheaper for the government than having to spend billions in future on making up the public pension fund deficits.

The case for helping local authorities to invest their assets in long-term infrastructure projects can also be extended to private sector pension funds.  While local authority schemes have around £140bn in assets, private sector schemes have many hundreds of billions more.  Harnessing this money as well, by providing incentives or underwriting inflation-linked long-term returns (say guaranteeing an inflation-linked income stream in 10 years' time) could help employers struggling with their deficits and also help increase UK long-term growth.  This could be a great investment opportunity that can improve diversification and help reduce the risks of bond investing.