The treasury has unveiled plans to boost pension pots for savers and potentially unlock billions in investment by dramatically reshaping the UK’s pensions landscape.
Under the reforms, “pension megafunds” will be created by consolidating defined contribution schemes (DC) and pooling assets from the 86 separate Local Government Pension Scheme authorities.
The new UK megafunds will imitate pension arrangements in Australia and Canada, where funds use their large size to invest in assets that have higher growth potential. This helps boost fund members’ savings and in the UK could unlock access to about £80 billion of investment for new businesses and infrastructure.
The government is consulting on these changes and finalised reforms will be introduced in a new Pension Schemes Bill next year.
Threat to small schemes
However, a government consultation that will help decide the minimum size for pension funds suggests that small DC schemes could be at threat of closure even if they perform well for savers.
Analysis in the government’s interim report ‘Pensions Investment Review at Mansion House’ found that funds offer much greater saver returns when their assets are between £25-50 billion. With this amount, pension funds are able to invest in a wider range of assets, such as start-ups and major infrastructure projects, it found.
Much larger pension funds, with more than £50 billion of assets, have the added advantage of being able to invest directly in large scale projects such as infrastructure at lower cost, it said.
Canada’s pension schemes invest about four times more in infrastructure than UK DC providers, while Australian pension schemes invest about three times more in infrastructure and 10 times more in private equity, the government said.
UK fund landscape
At the end of 2023, there were seven UK providers with more than £25 billion of assets, according to the Corporate Adviser Master Trust & GPP Report. Since then two more providers are likely to have passed the £25 billion mark.
The Corporate Adviser Pensions Average (CAPA) performance data shows that several smaller funds, including the Aon Mastertrust, Lifesight and SEI, all with less than £11 billion in assets at the end of 2023, have consistently outperformed other providers.
The government’s consultation on the reforms will also examine the process for consolidating schemes into megafunds, and potential legislation that would enable fund managers to move savers from underperforming schemes to ones that deliver higher returns more easily.
Chancellor Rachel Reeves said: “Last month’s budget fixed the foundations to restore economic stability and put our public services on a firmer footing. Now we’re going for growth.
“That starts with the biggest set of reforms to the pensions market in decades to unlock tens of billions of pounds of investment in business and infrastructure, boost people’s savings in retirement and drive economic growth so we can make every part of Britain better off.”
How will it work for employers?
Charles Cotton, senior reward adviser at the CIPD, said: “While the creation of the pension megafunds has the potential to improve pension outcomes, some scheme members reading the press coverage will be anxious about how this move could affect them. Therefore, it is important that the government lets members know as quickly as possible about the governance safeguards that will be put in place to defend both their money and their personal information.”
Barnaby Low, senior portfolio manager at Charles Stanley Fiduciary Management, added that pension scheme trustees and employers will be keen to see how the government plans to make this work within the framework of their existing duties.
“If done well, this could provide additional incentives for defined benefit pension schemes to run schemes on for a longer timeframe and potentially capture more value for members and employers,” Low said.
Simon Kew, head of market engagement at consultancy Broadstone, said: “Mega is better when it comes to the government’s pension reforms. The chancellor appears to have recognised the challenge – and controversy – of mandating investment in asset classes so is pivoting to enforcing economies of scale to get the allocations the country needs.
“The plans to merge LGPS into a handful of megafunds will need to deliver true consolidation in the management of these funds to obtain the investment impact that the chancellor hopes for from the combined £500 billion in assets. It is pleasing to see an emphasis on supporting local growth given the strong track record some LGPS funds have investing in their area.”
Kew said that DC consolidation is, generally, a hugely positive step. But he added: “One concern might be around fees, especially for smaller pension pots, but these savers should also benefit from greater investment returns and ‘safety in numbers.’
“It is pleasing to see the government looking to establish strong governance protocols to further protect members and, with that, will come the fiduciary responsibility to invest appropriately.
“Freeing up pension fund investment in UK PLC and much-needed infrastructure is certainly a prize worth fighting for whilst retaining a laser-focus on value for members.”
