Chancellor Rachel Reeves last week unveiled a new policy to force pension pots to operate at “megafund” levels, in a bid to free up money for investment to get around her self-imposed borrowing rules.
The changes will mean that pension funds will be encouraged to move away from their traditional safe investments such as government bonds into high-risk and high-reward private capital markets.
But experts predict that this puts savers’ money at heightened risk and could jeopardise retirement plans – as well as putting extra strain on the public finances.
The Treasury has hailed the plans as both unlocking investment, which it hopes will boost the flagging British economy, as well as delivering higher returns for savers.
Dr King Omeihe, a senior lecturer at the University of the West of Scotland’s business school, said that on the face of it, the plans seemed like a “win-win”.
However, because defined contribution pensions – where savers are not guaranteed a return – are dominant in the UK, gambling the money in turbulent markets puts cash at greater risk than traditional pension investment strategies, he warned.
Dr Omeihe said: “When you channel these funds into private markets such as early-stage businesses or infrastructure and private equity, there is that potential for high-growth returns. But high returns also mean high risks, so what that means is there is a high degree of volatility.
“Markets can swing widely and they are often much harder to predict than traditional investments.
“If things go well, people’s pension pots could grow faster, retirement could come with more financial comfort. But if it doesn’t, the savers risk reaching retirement with retirement pots lower than expected.”
The academic called on the UK Government to introduce “concrete” protections for savers to accompany the reforms, saying: “These pots are not just abstract pots of capital, these are people’s lifetime savings and people deserve that growth and that security.”
Parallels have also been drawn between the Government’s liberalising reforms and the conditions which led to the subprime mortgage crisis in the US, which triggered the 2008 global financial crisis.
Both the lending crisis and Labour’s pensions reforms involve investors gambling with money which is intimately tied to people’s everyday lives.
Subprime mortgages allowed people who would otherwise not have been able to afford to buy houses to do so – however, when that money was called in by the banks, many found themselves unable to keep up with repayments and had their homes foreclosed.
Dr Omeihe said: “You look at the subprime mortgage crisis in 2008, there was this strong political push to unlock capital. This was done through housing, mortgage-backed securities. What we are seeing now is pension megafunds are being promoted as tools to spread risk and boost returns.
“Subprime borrowers at that time didn’t understand what they were signing up for and similarly, today, many pension savers don’t have insider control over where their money is being invested and especially in private markets where, I think, there are sometimes opaque valuations.”
He added: “There is strong political enthusiasm to invest in Britain, just as there was political will then in the US to expand homeownership. But that overconfidence in the markets can either self-correct or sometimes it can blind policymakers to potential vulnerabilities.”
Dr Isaac Tabner, a senior lecturer in finance at Stirling University, echoed Dr Omeihe’s concerns about the risk savers will be exposed to by having their money invested in private markets, warning that in the event of a market crash, defined contribution savers could take a “major hit”.
He also raised concerns about the Treasury’s designs to free up capital to be invested into British businesses – saying this “concentrated” risk in one place.
Announcing the plans, the Treasury bemoaned the fact that only 20% of defined contributions assets were invested domestically, compared with 50% in 2012.
Dr Tabner said: “It’s fairly well-established that if you’re investing, you benefit from international diversification. You’re not putting all your eggs in one basket.
“A lot of studies show that even US investors benefit from buying overseas investments and the US is obviously the largest equity market and one of the largest economies in the world.
“Britain is a much smaller economy, so relative to the size of the world investment portfolio, it makes sense that UK investors would probably have between 5-10% of their savings invested in the UK market and the rest overseas, from a risk-management perspective. This proposal seems to fly in the face of that from an investors’ point of view.”
He argued that encouraging pensions to invest in the UK economy may be beneficial in the immediate term by increasing growth, it “may do so at the expense of currently retired or future retired” workers.
Dr Tabner also raised further concerns about the impact the reforms may have on the bond market, which influences interest rates.
Pension funds have traditionally invested in government bonds because they are seen as a safe investment. But a decline in demand, fuelled by pension funds abandoning bonds in favour of higher-return investments, may push up interest rates, Dr Tabner warned. This would, he added, make it more expensive for companies to borrow money.
And by pushing funds to invest in British businesses, Dr Tabner said there was a risk that it could compound savers’ losses if there is a market crash at the time they plan to retire.
He drew a parallel with the collapse of the company Enron, which saw employees lose both their incomes when the firm went under and their savings because they had been encouraged to buy company shares which became worthless.
However, the plan does have backing among titans of finance, including Michael Moore, the head of the British Private Equity and Venture Capital Association, who described the plans as a “win-win” for both the economy and savers.
He said that evidence from Canada and Australia, which have pursued similar agendas, showed how the reforms would “help the national economy and deliver better retirement outcomes”.
A Treasury spokesperson said: “Savers’ interests are at the heart of our pension reforms. Pension funds have already committed to private market investment targets voluntarily, due to the potentially higher returns and security for savers through diversified asset holdings that they offer.”
