UK pension savers are already used to jargon but will have to add “megafunds,” “LTAFs” and “legislative backstop” to their lexicon following substantial changes made to the industry in recent weeks.
The Labour government, less than a year in power, is keen to overhaul UK pensions with a view to improving returns for the £800 billion invested in UK defined-contribution schemes and create a virtuous circle where this investment boosts the ailing domestic economy.
The UK is looking to Australian and Canadian “megafunds” for inspiration, as well as mandating investment in private assets and UK infrastructure projects.
Here the UK government is taking a more active role in private pension planning, with the proviso that it can intervene if the industry is not making sufficient progress.
UK Pension Giants Sign Mansion House Accord
The UK pensions industry remains broadly supportive of government efforts to reform the pensions system to support economic growth, but concerns remain over a government decision to reserve the right to mandate asset allocations. A mandated 10% investment in private capital has raised fears of government overreach. It could also signal a shift away from UK listed capital at a time when London is struggling to attract new IPOs and keep companies from shifting listings to more liquid markets like the US. There are also doubts whether “outcomes”, the new focus of UK regulators, will actually improve for UK pension savers.
A policy more than two years in the making, the changes fall under the moniker of the Mansion House Accord, which was signed by 17 workplace pension providers in May—including Aviva, Legal & General, Royal London, and the government’s own auto-enrollment provider Nest. Signatories agreed to allocate 10% of their default funds into private market assets by 2030, of which at least 5% will be in UK assets.
That itself was a development of a plan initially outlined under the previous Conservative government led by Rishi Sunak and chancellor Jeremy Hunt; this agreement was signed in 2023 and known as the Mansion House Compact. At the time policymakers were pushing financial deregulation as a way of boosting lackluster domestic equity returns for the benefit of long-term savers.
Investing in Private Markets
Nevertheless, questions remain over the precise nature of the proposals, which include a commitment that pension providers will invest in infrastructure and UK assets, and an expansion of pension schemes into private markets and long-term asset funds (LTAFs).
“Private markets can offer a valuable illiquidity premium, broadening the range of investment options and potentially improving returns in the long run, but this premium isn’t guaranteed or constant, and higher fees can act as a drag on returns,” says Morningstar chief research and investment officer Dan Kemp.
“While investors will indirectly benefit from increased growth in the UK economy, mandating where capital is invested may lower returns and introduce additional risk.
“Pension schemes now face a balancing act; they will need to address how they navigate this commitment alongside their duty to end investors to provide attractively priced private investment options.
“The announcement is focused on stimulating and supporting British industry, rather than prioritizing investor outcomes.”
What is a Pension Megafund?
A central component of the chancellor’s plan is the creation of pension “megafunds” with more than £25 billion in assets.
This is a replication of a model already tried and tested in countries like Canada and Australia, where the defined-contribution (DC) pension markets are more mature.
That model involves the consolidation of smaller DC funds into much bigger vehicles—with the supposed benefits of cost efficiency and purchasing power.
This is where pension providers are performing a tricky balancing act—between supporting government engagement with the pensions industry at large, and skepticism over the practical implications of the policy itself.
“There is much to be said for pension fund consolidation, toward a model seen in countries like the Netherlands and Australia,” says Evelyn Partners managing director Jason Hollands.
“The key tangible benefit should be the cost efficiencies that greater scale brings, because, as those feed through the end-saver, that will mean less erosion of returns.
“The other benefit of pension ‘megafunds’ emphasized in this report is ‘risk-pooling’—the argument that bigger schemes will be better positioned to have exposure to less liquid, private market assets.”
The use of these larger structures to access private markets and LTAFs is what worries others, however.
How Will Pension Funds Access Private Markets?
The use of risk pooling is central to the Mansion House Accord and its relationship with so-called “default” funds, preprepared wrappers savers’ money is invested in.
Typically they have a risk grading of “moderate” or “balanced”, which is usually a mix of listed equity and bond exposure to limit risk and volatility.
All that could be about to change, however. The Mansion House Accord includes a supposedly “voluntary” agreement that signatories will allocate 10% of their default funds into private market assets by 2030, of which at least 5% will be in UK assets.
The thinking is that this will give savers better access to attractive returns. But that opportunity is itself subject to market factors, including interest rates and bond yields.
“The timing of this expansion into privates needs to be considered,” says Morningstar equity strategies analyst Daniel Haydon.
“Traditional institutional investors in private markets are retrenching. Private market asset managers are targeting any source of growth they can.
“Performance expectations must also be realistic. We are not in the 2010s anymore. You cannot rely on multiple expansion and leverage alone to generate performance.”
Private Credit Could Be Increasing Risk
Haydon is also concerned about the inclusion of private credit in the push toward private markets. An alternative to traditional bank financing, private credit is a form of lending and investing that takes place between private companies or extremely wealthy individuals. This, Haydon, says, is among the riskiest of the plan’s elements.
“I think potential risks are brewing in this space,” he says.
“Some covenants look rather weak, and there is a notable rollover of debt incoming, and divergence between default rates for bank loans versus high-yield bonds.
“Spreads versus public debt are not as attractive as they once were either. Though the inflation-protective characteristics of floating rates are attractive, this does translate to increased credit rates if—and when—rates go up.”
How Do LTAFs Work?
One way pension funds may potentially access such opportunities is via LTAFs. A relatively new FCA-regulated fund structure, LTAFs were introduced in November 2021, and are designed to offer easier access to longer-term illiquid assets like private equity, venture capital, infrastructure, and private debt.
Many master trusts, a structure of pension based on a legal trust that supports the participation of several employers at once, are already using this type of fund, often via commercial deals. Examples include Phoenix’s tie-up with Schroders Capital: Future Growth Capital (UK LTAF), and Aegon Master Trust, which is working with BlackRock and JP Morgan. Here, the specifics really matter.
“Dispersion of returns for traditional private market funds is very wide,” Haydon says.
“Manager selection is critical, and a question remains about whether LTAFs and other evergreen structures truly have access to best in breed managers.
“Getting the wrong exposure to the right asset class will prove painful.”
What Does it Mean for My Pension?
For those already invested via their auto-enrollment pension funds, much of these changes will likely take place out of sight. Savers may not even have to do anything.
That said, the extent to which governments grant control over asset allocation to pension provider signatories to the Mansion House Accord is still a worry for some.
The government’s latest Pension Schemes Bill includes a reserve clause that allows it to dictate precisely how much money providers allocate to specific assets. This “legislative backstop” allows the government to dictate the pace of change if it decides that not enough progress has been made in the next five years.
Who’s in Charge of Your Pension?
Tim Box is chair of the Pensions Management Institute’s policy and public affairs working group. His view on the matter implies that the fiduciary duty of pension schemes to put investors first could be considered to override any government edict.
“For those running UK pension schemes the ultimate responsibility is to act in the best interests of members. Pension funds will invest where opportunities align with long-term value and security,” he says.
“The ambition in these proposals is large and the overall proposed timescales relatively short given the size of changes proposed. Beyond investment choices, practical implementation must be considered. Industry bandwidth to support consolidation and reform is finite, and sequencing matters.
“Rushing change risks confusing savers and undermining confidence in the system. Any reforms must be structured to ensure clarity, stability, and a smooth transition for members.”
James Gard contributed to this story.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
