Why the UK must make the Mansion House Reforms a reality

The speech delivered this week by British Chancellor, Jeremy Hunt, to City executives at Mansion House in London got a lot of people thinking about pension reform. 

In his speech, Hunt set out a list of changes that he intends to make to reinvigorate the UK’s financial services sector, seeking to fire up the ailing UK economy. 

Amongst these, Hunt stated how he wanted to revamp elements of the pension industry. The core of the package of measures has been dubbed the “Mansion House Reforms”, and they include plans to unlock more pension money to invest in UK startups and scaleups. 

The size of the problem 

At first glance, this sounds encouraging, especially when you think about the size of the problem that this measure is looking to overcome. 

Despite a thriving UK tech sector, most of the cash invested in startups is tied up with LPs of VCs and comes from overseas, including large overseas pensions and SWF funds. In later rounds of funding, VCs are typically international, mostly from the US. This means that most successful UK scaleups get dragged away from these shores once they reach scale. 

This seems to me to be a big mismatch and a wasted opportunity, as it’s not as if the UK doesn’t have a mountain of pension assets sitting at home. It does, but it is a quirk of regulation and culture that those assets have historically been invested in gilts/fixed income, and less invested in public and private equity.

Historical shortsightedness 

According to this passage from the FT, the history of this trend to lock up pension funds in more traditional assets is largely due to a series of accounting changes that took place in 2000:

“Among the most significant changes was the introduction in 2000 of FRS17, an accounting standard that required companies to calculate the surplus or deficit on their defined-benefit pension schemes each year and disclose any deficit as a financial liability in their accounts just as they would a bank loan or a bond issue. Company boards, often shocked by both the magnitude and volatility of liabilities, rushed to close  defined-benefit schemes, first to new members and then to further accruals. Trustees began shifting assets out of equities — the asset class that historically has delivered the highest inflation-adjusted returns — and into government bonds. The theory of this “liability-driven” investment strategy was that it was lower risk, but for many pension schemes it came unstuck last autumn when bond prices fell sharply following the UK government’s “mini-Budget”.”

It’s easy to see the size of the opportunity currently being missed when we look at how pensions in other parts of the world are set up, and why, if implemented, Hunt’s plan could transform both the UK economy and the tech sector. 

Canada’s Ontario Teachers Pension Plan is one of the world’s most successful pension investors. The main reason why it has generated superior returns is that it pivoted away from bonds into equities and infrastructure over the last 30+ years, during which time tech stocks (public and private) boomed. Canada has capitalised – the UK has missed out. 

Hard to shift 

Overall, the reforms set out by the Chancellor look exciting. But, as with the early workings of any great plan, for now, they remain mere “suggestions” rather than concrete rule changes or actions that will make a real-world difference. 

Changing behaviour is hard, especially in large, slow-moving parts of financial services, such as pensions. Throughout history, the fact that equities return more than fixed income has been proven. Yet, in the UK, equity allocation has fallen from 56% to 29% over the past 20 years whereas the average asset allocation in global pension assets to real estate, private equity and infrastructure in the 20-year period has moved from about 7% to above 26%. 

In the UK, the link between pension under/over-funding and accounting losses has led to weird behaviour when investing pension assets. For example, this was clearly illustrated by the “liability-driven-investment” crisis after last autumn’s mini-budget, where pension funds seemed to care more about managing accounting results rather than generating real returns. 

Actions speak louder than words 

Given these entrenched behaviours, Hunt and his colleagues are going to have to create the right environment and offer the right incentives to enact change. To my mind, the UK needs to be bold, rip up those out-of-date practices and crazy accounting rules, and give pension funds the freedom to invest in a way that maximises returns, wherever those returns may be. 

It’s a little embarrassing to see similar-sized economies all over the world make better use of their pension assets. The strategies of Canada, Australia, Sweden, Norway, the Netherlands etc should be picked over so that we can learn how to get the most out of our own assets. In addition to maximising the returns for funds, reform would be a huge boost for our tech sector, both in terms of short-term investment as well as creating a climate where tech cos are incentivised to remain for the long run. 

To achieve this, strong intentions and a good plan are essential, and Hunt’s speech outlined the bare bones of these. What’s needed now is the boldness and courage to put those plans into action and turn these good intentions into reality.