Forecasts show pushing UK pensions into private markets will make ‘tiny’ profits

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The push to get UK pension funds to invest more in private markets will see returns rise by just 2 percent over a 30-year period, according to the government’s own forecasts.

In her Mansion House speech earlier this month, Chancellor Rachel Reeves announced proposals to create a series of “megafunds” in the UK’s £1.3 trillion defined contribution and local authority pensions industry to attract more investment in UK infrastructure projects and startups.

Policymakers also argue that larger pension funds with greater exposure to private markets will provide greater returns for savers.

But projections from the government’s actuarial department show that its model “private market” portfolio – with 10 percent of assets allocated to infrastructure and 5 percent to private equity – has returned just 2 percent more over 30 years than its equivalent “benchmark” portfolio excluding access to private markets.

It is estimated that defined contribution schemes currently allocate an average of 1 percent of assets to private investment and 3 percent to infrastructure.

“(It’s) a small difference given the uncertainty when you’re modeling pension savings over decades,” said Steve Webb, a former Liberal Democrat minister and now a partner at pensions consultancy LCP.

“It’s not a loud endorsement if good outcomes for members are your top priority,” he added.

The government’s calculations were based on Moody’s capital market assumptions. Higher fees charged in private markets may be one reason for the lack of improvement in returns—forecasts assumed fees of 1 percent and a 10 percent performance fee for private markets, compared to a 0.25 percent fee for all other assets . classes.

The government has outlined plans to consolidate pension assets into portfolios of at least £25 billion through defined contribution funds and local authority funds. It is estimated that the move could free up up to £80 billion of capital, which will be redeployed to invest in UK infrastructure projects and high-growth businesses.

In the “low risk” scenario, the government forecasts that the private market portfolio will return 4 percent higher than its benchmark counterpart (as infrastructure typically has a lower risk profile than equities), but in the “high risk” B if that advantage collapses to 0.3 percent over a 30-year period.

Speaking about raising funds in the private markets, Tom McPhail, director of communications at consultancy Lang Cat, said: “The government’s argument that they have identified an investment opportunity that the entire pensions industry has collectively and repeatedly ignored seems weak and a bit desperate. “

But he added that there is a “strong argument” that UK pensions should be consolidated into “fewer, larger and better managed schemes, which are then likely to provide improved value for money”.

In an interview with the Financial Times last week, Pensions Secretary Emma Reynolds said she needed pension funds to invest more in UK infrastructure and start-ups.

She also said she was “convinced that larger schemes would deliver greater returns”, pointing to Australia’s most successful defined contribution pension funds, which she said had outperformed UK peers and had much higher allocations to private investment and infrastructure . .

But when asked whether pension plans would have been more effective if they had invested the way she wanted over the past decade, she said it was “hard to say.” She also said the government could consider forcing pension schemes to invest more in UK assets if reforms fail to deliver savings in domestic infrastructure and companies.

Tom Selby, director of public policy at AJ Bell, said there was “absolutely no guarantee” that increased private equity investment would bring greater returns to pension schemes.

“The danger of combining state economic policy with public pensions is that the latter will be put at risk in pursuit of the former. . . Any claim that private equity guarantees higher pensions should be viewed with extreme skepticism,” he said.

A Government spokesman said the Chancellor’s speech at the Mansion House was “the first step towards transforming our fragmented pension system, with measures designed to unlock £80 billion to boost growth, investment in exciting new businesses and critical infrastructure, while increasing defined savers’ pension pots contributions.” .