The Chancellor’s push for more UK investment by pension funds puts savers’ money at risk, experts warn
Inside the pensions crisis
Retirement feels more uncertain than ever, with nearly six in 10 adults unsure if they have enough time to save for a pension. Successive governments have struggled to address the issue. So, how did we get here, and what can be done to fix it? The i Paper brings you the essential stories on what went wrong with pensions, along with expert insights into the policies and solutions that could help secure your financial future.
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Pension reforms to increase UK investment as part of the Government’s economic growth mission could leave savers thousands of pounds worse off in retirement, experts have warned.
The Chancellor’s push for more domestic investment – dubbed “pension fund nationalism” by some commentators – will risk savers’ money in the name of political objectives, The i Paper has been told.
In her Mansion House speech in 2024, Rachel Reeves set out plans to force pension funds to combine into “megafunds”, saying they could unlock £80bn of investment in the UK.
By pooling the pots together, the Chancellor hopes it will give pension schemes the firepower to invest in a broader range of UK assets, including infrastructure.
Under the proposals, the UK would introduce a minimum size for defined contribution pension schemes, a type of retirement savings plan where the amount someone receives in retirement depends on how much they and their employer have invested – and how well that investment has performed. Most people working in the private sector have this type of pension.
The local government pension scheme, a large public sector scheme for people working with and for local government, will have its 86 separate funds condensed into fewer, bigger pots.
The push for UK investment and bigger pension funds will affect both defined contribution (DC) schemes and defined benefit (DB) schemes.
DB schemes, also known as final salary pensions, offer guaranteed returns based on the length of someone’s employment and their final salary – providing a guaranteed income for life. These are more common in the public sector.
But Tom Selby, head of public policy at investment platform AJ Bell, warned that “conflating” a government goal of driving investment in the UK and people’s retirement outcomes “brings a danger because the risks are all taken with pensioners’ money”.
This is because pension funds make investment decisions to get the best outcomes for savers, which has limited investments in UK-based infrastructure projects with uncertain returns, Selby said.
“The desire to get more pension money invested in the UK is understandable, but my overarching concern is that the needs of the saver, whose money is ultimately going to be risked, will be forgotten about,” he said.
There needs to be “some caution” in “this push to use other people’s money to deliver economic growth”, which could go wrong.
“Ultimately, the best way to encourage capital flows to UK businesses is to pursue reforms aimed at making the UK an attractive place to invest, rather than simply forcing people to invest here,” he added.
Why experts are worried
Around 20 per cent of workplace DC assets are invested in the UK, down from around 50 per cent a decade ago, according to the Department for Work and Pensions.
Around 30 per cent of public-sector DB funds are invested in the UK, mostly in UK equities, government bonds and property.
Steve Webb, a former pensions minister and now a partner at pensions consultancy LCP, said his “biggest reservation” about the reforms is that the saver “is at the bottom of the pile of all this – they’re almost an afterthought”.
The Government’s own modelling found that moving 20 per cent of DC pension funds’ assets from overseas equities to UK equities – private and public stocks and shares – would deliver “similar returns” to the current strategy. Seventy per cent of private sector DC funds are currently invested in overseas equities.
For a member earning £30,000 per year saving at 8 per cent for 30 years, the change would deliver returns “slightly above” other strategies, though each pot would deliver between £330,000 and £340,000.
The modelling by the Government Actuary’s Department, published by the Department for Work and Pensions last November, assumed that UK equities would outperform overseas equities by one percentage point over 10 years, citing forecasts from JP Morgan, Blackrock, Amundi and other investment firms. Moody’s, the leading credit rating agency, has predicted roughly equal returns.
In a chart with the modelling published by the DWP, the Government’s Actuary Department predicted that the current strategy would yield average returns of £340,936, compared with £341,587 for the pension with more UK equities – a difference of £651.
However, if market conditions over the past 20 years persist, in which UK-focused investment strategies have underperformed overseas equities by about four percentage points per year, it would result in “smaller” pension pot sizes, the DWP said.
In this scenario, the pension with more UK equities would be worth about £329,000, while the current strategy would yield returns of £338,000 – a difference of £9,000.
Webb said: “Thirty years hence, when all of this has worked its way through, you might get to, on average, a slightly bigger pension pot.
“That’s a very long time and a lot of cost and disruption. The first concern is that the member [of the pension scheme] is just not really at the heart of this.”
He said pension funds have moved the share of their equities in the UK down over time to take advantage of opportunities in other markets, such as in the US, where tech stocks have been lucrative.
“By investing in shares around the world, we are insulated against any one economy doing badly,” he said.
Jonathan Greer, head of retirement policy at wealth manager Quilter, said trustees that manage pension schemes are required to seek the highest returns for their members, which has “led to a significant globalisation of investment” in recent years.
So far, the Government has said it wants to encourage more UK investment rather than make it mandatory, which Greer said would be a step too far that would provoke backlash from providers.
“Their concern is that UK market historically has underperformed,” he said.
He added that the success of the Government’s plans will come down to whether trustees can see value in the UK market.
Rob Yuille, head of retirement policy at the Association of British Insurers, a trade body that represents many pension firms, said savers’ interests “must come first”.
“Government has consistently said it has two objectives, one of which is savers’ interests, and the other of which is UK growth,” he said. “They can go hand in hand, but firms will invest on the basis of what is in their customers’ best interest.”
Yuille said there is “some debate” about the extent to which the reforms would provide greater returns for savers.
“Part of the reason why firms are not invested in certain assets is that they are risky,” he added. “The scope of returns is higher, but they might cost more.”
The risks of megafunds and infrastructure investments
Infrastructure projects in the UK are risky for investors partly because they are beset with delays, cost overruns and cancellations by subsequent governments, Greer said.
Shortages in engineers and skilled trades could also make it more difficult to get such projects completed.
Greer believes the Government’s planning reforms and removal of “red tape” are part of its attempts to make investing in UK infrastructure more attractive.
Infrastructure investments are also difficult to sell quickly, which can pose a challenge for pension schemes because they need to be able to give cash back to savers on a regular basis.
Having bigger pension schemes should help with that – the bigger the pension scheme, the more money they have to balance out infrastructure investments with other, more easily saleable options, Greer said.
But the Government’s plans to make pension funds a minimum size have other drawbacks that could hurt consumers.
Webb said the pensions market could end up dominated by a “small number of megaliths” that “all do much the same thing”, which leads to a lack of competition and innovation.
Yuille agreed that this was a concern that needed to be addressed. “There needs to be a way in for someone who wants to do things differently,” he said.
In a consultation response seen by The Telegraph in January, senior bank bosses from Barclays, NatWest, Lloyds Bank, Nationwide and other large firms warned that creating megafunds risked harming innovation and leading to a “one-size-fits-all that does not meet the needs of individuals”.
The projects that could be targeted
Investments in the UK that could be targeted by politicians are expected to include long-term infrastructure such as building roads, railways and wind farms, Selby said.
“High-growth potential industries of the future”, such as life sciences and artificial intelligence could also feature, he added.
Some pension funds already invest in renewables, such as wind farms, as well as residential and commercial housing projects including build-to-rent, student accommodation and homes for sale, Yuille added.
Investing in the energy grid is another option.
“The obvious thing would be the move to a decarbonised energy grid,” said Webb. “If we think burning gas isn’t for the long term, then all our cars have to be electric. Home heating has to be hydrogen or electric.
“We all need home heat pumps and solar panels, and the grid needs to be completely rewired to get power from the offshore wind farms in Scotland, to where the actual power is needed.”
Other projects the current Government has indicated it wants prioritised include battery gigafactories, green hydrogen and green ports, he added.
To make infrastructure investments more attractive, the Government is looking at offering guarantees to offset risks, co-investing with public money and changes to make projects comply with regulations, according to the Association of British Insurers.
One option is for infrastructure firms to issue debt, borrow money from pension schemes and pay them interest, Webb said.
A second is for pension funds to invest directly, sometimes in partnership with government agencies such as the British Business Bank.
Pension funds could band together with other investors to form a consortium to invest money into projects and own them directly.
Alternatively, pension funds could buy shares of firms.
In 2023, the previous Conservative government said it wanted pension schemes to invest five per cent of their default funds in unlisted equities – investments in companies that are not publicly traded on a stock exchange. This would be aimed at start-ups, Webb said.
“A lot of them fail,” said Webb. “That doesn’t mean they’re bad things for pension schemes to invest in, but it means that they need a breadth of investments, so across different sectors, for example biotech startups and green energy start-ups and AI start-ups.
“You’d want mechanisms that enable pension schemes to invest across, say, 100 startups recognising that 50 of them might fail, but one might be the next Microsoft.”
Bundling companies together could also make it cheaper for pension funds to invest in start-ups by saving them from having to individually research and analyse specific firms to pick winners, he added.
Another pension reform proposed could backfire and make investing in UK start-ups even less attractive, however.
The Government plans to assess the “value for money” provided by pension funds, which is designed to help savers compare schemes by taking into account returns and costs.
This could discourage pension funds from investing in UK start-ups because they tend to lose money in the first few years, Webb said.
“There is a real risk, and this is a risk the Government may make worse, that schemes won’t do this kind of thing because they’re being measured on their performance over one year, three years, et cetera, and that’s a disincentive to invest in something that has only a long-term payback,” Webb said.
Yuille agreed, adding: “Concerns have been raised about firms just not wanting to be at the bottom. So there’s a herding effect – a desire to be in the pack rather than take risks.”
How Australia and Canada compare
The Government has said its plans to create pension megafunds “mirror set-ups in Australia and Canada, where pension funds take advantage of size to invest in assets that have higher growth potential”.
However, experts said the UK plans have significant differences.
Australia offers pension schemes a big tax break if they buy Australian shares, which is not in the UK’s plans.
“Ministers point to Australia and say, ‘Oh, look, they invest all in the home economy,’” said Webb. “Well, they do partly because they’re bribed with public money to do so. We don’t do that.”
The costs of such tax breaks would be huge, given that pensions are a multi-trillion pound industry.
Although they invest in more Australian stocks, savers “don’t necessarily do that much better, partly because the costs of the Australian system are higher”, Webb added.
Australian pension schemes also spend a lot more money on marketing to persuade people to choose their scheme, he said.
Australian funds are also much bigger because employers have to pay pension contributions worth 11.5 per cent of wages, Yuille said. In the UK, employers must contribute 5 per cent and employees pay another 3 per cent.
Canada has large-scale pension funds that invest in more infrastructure projects, but only a small proportion of their money is invested in Canadian infrastructure or Canadian firms, Greer said.
The Canadian government is developing its own proposals to try to get increased investment in its economy.
“Canada is probably wrestling with the sort of problems that we ourselves are wrestling with,” Greer.
In other countries, moving away from domestic investment in favour of a global strategy has proved to be more lucrative for pension funds and their savers.
South Korea has been shifting the investment strategy for its National Pension Service to focus on acquiring more global investments, which have fuelled rising returns.
In 2024, the fund posted a record 15 per cent return, with a 34 per cent return on its global stocks, followed by 17 per cent on global bonds and alternative investments, The Korea Herald reported. Returns were 4.5 per cent in 2015 and 10.7 per cent in 2019.
Global stocks made up 35.5 per cent of its assets in 2024, up from 23.1 per cent in 2020. An additional 7.3 per cent was invested in global bonds last year. The fund plans to raise its overall global assets to 60 per cent by 2028.
A Government spokesperson said: “Creating wealth and driving growth is at the heart of our Plan for Change. That’s why it was a priority for the Government to launch our landmark pensions review and announce a new Pensions Bill which could boost a defined contribution pot by over £11,000 in the first King’s Speech of this Parliament.
“Driving greater scale in pensions funds to deliver fewer, larger and better pension funds will maximise opportunities and provide greater security for those saving for their retirement, as well as driving greater investment into the UK to deliver economic growth.”
