Recent governments have not focused sufficiently on addressing the chronic short-termism of pension fund investments
The 2008 financial crisis and subsequent stagnation in the British economy gave renewed prominence to one of its longstanding handicaps. The relative lack of long-term investment can be associated with both the housing market and asset price booms which created significant volatility in the pre-crisis period, and with the sluggishness of the post-recession recovery which has ostensibly been underway since late 2009. Short-termism in investment practice is one of the key drivers behind Britain’s sluggish productivity growth.
Pension funds lie at the centre of this undesirable status quo. They are, to some extent, the victims of Britain’s economic short-termism. The economy (including the public sector) is not creating sufficient opportunities for long-term investment to which pension funds can allocate significant amounts of capital.
On the other hand, however, pension funds can be said to be perpetrators of chronic economic short-termism (although certainly not the main perpetrators). British pension funds are hugely significant capital-market participants. Their embrace of securitisation in the 1990s – which can be associated with responding to population ageing – had a transformative impact on investment practice in the City of London. More generally, pension funds also highly value liquidity in investment – that is, assets that can be traded quickly – and tend to trade some assets at a relatively high frequency in order to track investment benchmarks.
Given the vast size of British-based pension funds, it is not surprising that policymakers have looked to them in the post-crisis environment to reorient their investment practice towards the long term. Such a move would ostensibly facilitate the kind of ‘real economy’ investments that would strengthen the economic recovery.
Part of the problem, however, is that what long-term investment actually looks like is not always clear. There is also an acute shortage of detailed data on how pension funds invest, especially in terms of the balance between short- and long-term investments. My new paper, Take the Long Road: Pension Fund Investments and Economic Stagnation (published by the International Longevity Centre-UK), surveys the available evidence to detect a general tendency towards more acute short-termism, typified by the move away from UK equities in investment allocations.
Yet what qualifies as the ‘long-termist’ alternative is not always clear-cut. It is difficult to jump from evidence of short-termist investment practice to the conclusion that pension funds are employing short-termist investment strategies. There are a large number of issues which cloud any assessment of short- and long-termism, such as the relative lack of control of trustees over specific investment decisions in trust-based schemes, limitations and inconsistencies in how certain asset classes are reported and categorised, and the sometimes paradoxical role of short-term investments in supporting long-term investment by pension funds or in the economy more generally (and vice versa).
We need to define long-termism broadly in terms of investors accepting a degree of uncertainty in investment decisions, rather than simply higher risks. The possibility of significant returns depends on the investment itself, or the investor, having a transformative impact on the recipients of the investment, or the environment within which they operate.
On these terms, it seems clear that Coalition and Conservative government policies around pension-fund investments have largely failed to challenge short-termism. A ‘nudge’ agenda, typified by the establishment of the Pensions Infrastructure Platform, has failed to encourage greater pension fund investment in infrastructure. Insofar as pension funds are investing in infrastructure, they are using securitised debt instruments to replace, rather than augment public investment.
The dismantling of risk-sharing mechanisms within the British pensions systems is one of the main reasons that pension funds have been unable to embrace the uncertainty of genuinely long-term investments. This process has intensified since 2010. Where risks are shared, uncertainties can be tolerated. Yet the pensions system has become rapidly individualised, with the Coalition government’s embrace of ‘liberation’ within the annuities market undermining its own efforts to reintroduce an element of risk-sharing within highly individualised ‘defined contribution’ (DC) schemes in the form of collective DC provision. The point is that collective DC schemes depend on more constraints around annuitisation, not fewer.
Some stakeholders – and indeed policymaking elites – have sought to equate long-termism with the agenda around responsible investment. A stronger focus by pension funds on issues around corporate stewardship would probably be beneficial to the prospect of increasing long-term investment (although the evidence is mixed) – yet this is the most underdeveloped aspect of the responsible investment agenda. John Kay’s review of long-term decision-making in UK equity markets strongly endorsed stewardship, yet failed to consider why specific group of investors, such as pension funds, have thus far resisted greater responsibility for corporate stewardship.
As well as defending and promoting traditional, collectivist ‘defined benefit’ pensions – the demise of which has been unnecessarily hastened by poor national and European regulations and the short-termism of employers in a financialised environment – Take the Long Road also advocates the establishment of a national renewal funds with a mandate to allocate capital to projects that would enhance the productive capacity of the economy. They would be funded by a near-compulsory allocation by all workplace pension schemes (which would have to invest in the fund if they wish to continue benefiting from pensions tax relief on incoming contributions), including both defined contribution and defined benefit schemes. Minimum allocations could be set at a relatively low level (5-10% of fund value) and, as such, would not significantly disrupt existing investment strategies.
The fund would be sponsored by government, but it would be run independently, with business, trade union, local government and voluntary sector leaders included within its governance arrangements. Any individual or firm would be free to bid for investment by the renewal fund. The fund would retain an equity stake in any investee enterprise to ensure that pensions savers derive a long-term benefit from participation.
Although the national renewal fund would have a specific mandate to invest in projects throughout Britain, this does not mean that local renewal funds should not also be established. The state could again use the carrot of pensions tax relief to ensure that a certain proportion of all pension contributions are invested into a network of overlapping local pension schemes, investing predominantly in the geographical areas where members are based, rather than in the main pension scheme selected by the employer.