Investing for the long term: boosting returns for pension savers

The Mansion House Compact has brought industry together to call for change and has created demand for unlocking investment into high growth firms in the UK.

Initiatives such as the Long Term Asset Fund (LTAF), the Long-term Investment For Technology and Science (LIFTS), and an industry initiative to create a Future Growth Fund, are looking to meet this demand in different ways.

So why are pension reforms needed and why are these new vehicles and initiatives gaining momentum? 

A problem that’s been a decade in the making 

Since auto-enrolment was introduced in the UK in 2012, the transition from Defined Benefit (DB) to Defined Contribution (DC) workplace pension schemes has caused a shift in the investment landscape. DC pensions are growing and expected to reach over £1tn by 2030. But they have historically underperformed compared to DB pension schemes. The DC market has been driven by finding the cheapest fees and keeping costs low, which has led to trustees overlooking assets that could deliver the best longer term outcomes.

The employer, the buyer of pension funds, won’t usually have a deep understanding of the outcomes of their investments. You can get a pat on the back for reducing costs, by switching to a scheme with lower fees. But it’s a much harder sell to illustrate what a greater allocation to illiquids could mean, when that’s much further down the line. The procurement of schemes has focused on shaving costs and ultimately nobody is going to be sacked for going with a passive strategy.

Nathan Long, Senior Policy Analyst, Hargreaves Lansdown. 

Over time, UK DC pension schemes have contributed significantly less to illiquid and alternative assets such as venture capital and growth equity compared to DB schemes. This matters because institutional investors with high private assets allocations also earn the highest returns. So this gap in asset allocation, caused by a systematic reduced appetite for risk and prioritisation of low costs over returns, ultimately has an impact on savers. After all, 96% of savers don’t even choose their allocations and are placed into default investment strategies for their pensions. And only 14% of DC pension scheme members believe they are on track for a retirement income that maintains their current standard of living in retirement.  

Unlisted equity is one example of longer term investment in private markets that could help improve returns. A 22-year-old new entrant to a default DC scheme with a 5% allocation to unlisted equities could achieve a 7-12% increase in total retirement savings. 

In addition to savers being locked out of potential benefits, UK high growth firms are also missing out on much needed capital particularly from institutional investors. As highlighted in the recent Powerful Pensions report, a growth funding gap estimated as large as £1.5tn, can hamper their ability to grow domestically and compete globally.  

Private high growth companies, particularly in sectors such as tech, are often financed by private capital. But because of the shift to DC schemes, that pipeline of institutional investment from pensions has narrowed over time. Currently, just 1% of the £4.6tn in pensions and insurance assets is invested in unlisted UK companies.   

The Mansion House Reforms (of which the Compact is one part), aim to better enable pension funds to access illiquid assets by encouraging consolidation on DB and DC pension funds and a shift in focus away from costs and toward long term value.  

This is why new vehicles, initiatives, and commitments are needed – to respond to expected demand from pension companies, boost returns to pension savers, and to allow UK high growth firms to access the capital they need.   

How funds are taking action 

This year saw the launch of the first Long Term Asset Fund (LTAF). The fund is a new open-ended investment vehicle which shares the ambition of getting more money into pension savers’ pockets by unlocking investment into illiquid and longer term private assets. 

Nest is an example of a fund taking the initiative. The fund is the UK’s largest workplace pension scheme managing a private DC allocation. They will have at least £1.5bn invested in private equity by early 2025 and have stated a longer-term ambition to allocate 5% of their portfolio to private equity.  

For many years now, illiquid assets have been integral to diversified DC pension schemes around the world. It’s been a key driver behind Nest setting up our own private market mandates to ensure our members aren’t missing out. Nest will continue to increase our investment in unlisted equities, helping 12 million benefit from the strong returns these types of deals can typically offer. 

Mark Fawcett, CEO, Nest Invest  

To help drive Nest’s ambition, the fund appointed Schroders to pioneer the first LTAF.  The benefits of the LTAF include savers and investors having a wider set of options to connect pools of long-term capital with long-term investment opportunities. Amid an ever-greater need within the UK economy for such funding.  

There are some great industries and firms which could be further supported by long-term capital. The launch of Schroders’ first LTAF, which was the first to be approved in the UK, will enable these companies to start benefiting from big pools of capital and, in turn, help savers. 

Peter Harrison, Group Chief Executive, Schroders 

Since Schroders’ announcement, Aviva followed with the launch of the largest LTAF. The portfolio consists of £1.5bn in real estate assets, with the intention of delivering long-term value for institutional and professional investors and the UK.  

Our REALTAF is channelling capital to some really high quality investments, such as life science research parks around Cambridge for example. That’s allowing those sectors to grow and develop, and there are some great examples within the portfolio helping to drive growth in the UK economy.

Steve Birkett, Product Director, Aviva Investors 

Blackrock has become the third firm to launch a LTAF, while Schroders announced their second  focused on renewables and the energy transition. And Aviva have signalled more are incoming.  

Growing momentum and policy support 

For the first time in a long time. There’s been a confluence between policy makers, regulator, the management and client community about actually making something like this happen. The LTAF has been an industry wide effort. 

Mark Meiklejon, Head of Real Asset Global Investment Specialists, Aviva Investors 

Recent policy developments suggest the LTAF is likely to continue to gain momentum. The FCA has recently broadened LTAF access, so that retail investors can also participate, as highlighted in our State of the Sector report.  

LTAFs can be delivered fairly and safely to a wider net of investors such as retail. There’s still some remaining niggles such as how you can’t hold LTAFs in an ISA. ISAs are popular among retail investors, so there’s a big opportunity here and it could be a way to generate buzz around the vehicle. 

Nathan Long, Senior Policy Analyst, Hargreaves Lansdown 

Further, other new initiatives are getting off the ground, with the government’s Long-term Investment For Technology and Science (LIFTS) now calling for proposals. This initiative intends to crowd-in investment from institutional investors, particularly for DC pensions funds, to the UK’s most innovative science and technology companies. The Government will commit up to £250 million to support new investment vehicles or approaches to make these investments  and deliver Value for Money. It complements LTAF, with the latter cited a handful of times as an appropriate investment vehicle for the LIFTS funds. 

More broadly, the Department for Work & Pensions new Value for Money Framework aims to shift the industry focus on cost by incentivising consideration of other factors that feed into overall value for money and long-term outcomes. These include reducing pension poverty as well as encouraging wider economic growth. This shift in focus could help support the take-up of the LTAF and LIFTS in the coming years. 

There is still more to be done to unlock institutional investment for pension, including calls for a Future Growth Fund. This would be an investment vehicle and an efficient way for Mansion House Compact signatories to invest in private assets at scale. It could be structured as a LTAF.  

The Corporation will convene a summit of the pensions value chain later in October to build on the progress already made and continue to take the Mansion House Compact from intention to implementation. The Summit will focus on the cultural changes needed in each part of the chain in order to move capital. Attendees will hear from other jurisdictions to understand why and how it has worked well elsewhere and create a plan of action for achieving the wider objectives of the Mansion House Reforms (relating to DC scheme investment in unlisted equities).  

DC workplace pension schemes represent one of the largest growing pools of assets for households across the UK. Unlocking longer term investment for these pension funds is not only about increasing savings for people’s retirement, but also an increasing opportunity for growth in the UK.