Chancellor to create pension ‘megafunds’ to drive financial development – here is how it might work

Pension reforms: Rachel Reeves wants to unlock £80bn for investment in business and infrastructure, boost people’s  retirement pots and drive  growth

A government plan to use people’s pension savings to boost economic growth has broad public support, new research reveals.

In her Mansion House speech tonight, Chancellor Rachel Reeves will announce the creation of pension ‘megafunds’, by forcing mergers of smaller local authority and private work schemes to unlock £80billion of new investment.

Some 57 per cent of people want their pension to include a higher percentage of UK company shares – though 42 per cent said that was under the proviso it would not impact investment returns.

Meanwhile, 54 per cent want their pensions to invest more into private assets like housing schemes, infrastructure projects, and early-stage growth companies, according to the survey by Abrdn.

Its poll of 3,000 people, weighted to be nationally representative, found 14 per cent did not want this and 32 per cent were not sure.

The Chancellor’s plan to use pensions to boost growth is explained below, and it builds on predecessor Jeremy Hunt’s initiative in last year’s Mansion House speech to unlock extra pension cash to support the economy.

Hunt asserted his raft of plans – including getting top pension firms to allocate 5 per cent of their ‘default’ workplace funds to unlisted equities – would make make the typical saver £1,000 a year better off in retirement.

What does the Chancellor’s pensions overhaul involve?

Rachel Reeves plans to create pension ‘megafunds’ by consolidating defined contribution schemes below a certain size and pooling assets from the 86 separate Local Government Pension Scheme authorities.

She says this will unlock £80billion of investment in exciting new businesses, infrastructure and local projects, while boosting retirement savings and driving economic growth to make people better off.

The Treasury says the megafunds will mirror set-ups in Australia and Canada, where pension funds use their size to invest in assets with higher growth potential.

‘Canada’s pension schemes invest around four times more in infrastructure, while Australia pension schemes invest around three times more in infrastructure and 10 times more in private equity, such as businesses, compared to defined contribution schemes in the UK,’ according to the Treasury.

It notes there are currently around 60 different ‘multi-employer’ defined contribution pension schemes, and is looking to set a minimum size requirement for them to ensure they deliver on their investment potential.

The Government will hold a consultation on the reforms, which will then be introduced in a new Pension Schemes Bill next year.

Risks will all be taken with pension savers’ money

‘My overarching concern is that the needs of the saver, whose money is ultimately going to be risked, will be forgotten about,’ says Tom Selby, director of public policy at AJ Bell.

‘There’s a reason that an occupational scheme has a trustee to look after the interests of members. Part of that is investing their money to maximise returns and get the best retirement outcomes possible.’

‘Conflating a government goal of driving investment in the UK and people’s retirement outcomes brings a danger because the risks are all taken with members’ money.’

Selby says it needs to be made clear to pension scheme members what is happening to their money.

He points out trustees of of defined contribution default funds and defined benefit schemes are required to make investment decisions ‘first and foremost’ with the aim of delivering the highest possible income in retirement for members.

‘Good member outcomes are therefore at the heart of the UK pension system. Given we are likely talking here about pensions where the member is either disengaged in the case of defined contribution defaults or has no say over investment decisions in the case of defined benefit, it is crucial that remains the case.’

Selby adds: ‘If it goes well, everyone can celebrate. But it’s clearly possible that it will go the other way, so there needs to be some caution in this push to use other people’s money to drive economic growth.’

Megafunds will need a pipeline of viable investments

The success of merging local authority pensions funds so they are big enough to access high-yield investments will depend heavily on the availability of new infrastructure projects to invest in, according to Quilter’s head of retirement policy Jon Greer.

‘It’s a chicken-and-egg dilemma. Large funds need substantial, reliable projects to generate returns, but the market may struggle to offer enough of these opportunities, especially in the infrastructure sector,’ he says.

‘If too much money chases too few viable investments, the effectiveness of this consolidation could be diluted, with funds potentially forced into riskier or less impactful projects.

‘The Government will need to work actively to develop a pipeline of investable opportunities that align with the megafunds’ scale and risk requirements.’

Greer adds that improved oversight and regulation are welcome, but the additional layers of scrutiny could make megafunds slow-moving and burdened with compliance costs that ultimately affect returns.

‘It is also noteworthy that Reeves has stopped short of mandating pension schemes to invest a fixed portion of their assets in UK stocks or infrastructure projects, instead encouraging specified targets for the pool’s investment in the local economy.

‘While there is merit in driving investment into the UK, such mandates could have restricted pension schemes’ ability to make dynamic, return-focused choices.’

Greer goes on: ‘Reeves’s plan to support the UK economy is well-intentioned, but it is vital to balance this with the autonomy schemes need to protect savers’ financial futures.’