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We all know that (largely closed) private sector UK defined benefit schemes are bond-heavy and equity-lite. for reasons. This makes some people very cross.
We also know that the UK has a private under-investment problem and the government’s revealed preference around capital spending is to not.
In the words of Lin Manuel Miranda, maybe we can solve one problem with another and win a victory for the southerners. In other words — a quid pro quo.
Or, more prosaically, why not turn the Pension Protection Fund of East Croydon into a public superfund that consolidates the smallest 4,500 private DB schemes to invest in productive assets across the United Kingdom?
The Chancellor is curious about repurposing the PPF. Think Tanks are enthused. Even some investment consultants are positive. The government just closed its call for evidence on the question. And you know who really really loves the idea of making the PPF more than twice as big as the next largest pension fund in the UK? The PPF.
It’s not only because the PPF would get to manage (a lot!) more money. (There is little that investment managers won’t do for the chance to manage more money.) Having hired genuine in-house capability in a variety of asset classes, the costs per asset would likely fall — perhaps substantially. Furthermore, more concentrated ownership might enable stronger stewardship of holdings even if investment returns aren’t guaranteed to increase with fund size.
With pretty much every private sector defined benefit scheme in massive surplus (pension funding positions rise when bond prices fall), and the PPF’s own funding position hitting a monster 156 per cent, there has arguably never been a better time to go down the public consolidator route.
But there are at least two unanswered questions.
First, what sort of change in the level of “productive assets” would actually result from consolidating the 4,500 smallest schemes and turning the £32.5bn PPF into a (globally significant) £232.5bn PPF?
The PPF reckons it knows (with our emphasis):
Our Strategic Asset Allocation effectively mirrors that envisaged by the government, and shows what can be achieved through scale and taking a similar approach. As an illustration, if the smallest 4,500 schemes, accounting for around £200bn of assets, were to be consolidated in this way, this would suggest c. 30% (£60bn) could be allocated to productive finance assets.
Thirty per cent x £200bn = £60bn. No argument there.
But their submission reads as though consolidating small schemes into the PPF’s preferred asset allocation will deliver £30bn more ‘productive finance’ assets. (In a Humpty Dumptyish move the DWP defined the term as meaning equity capital, infrastructure, private equity and illiquids.)
Is this true? It’s hard for us to know exactly how this group of 4,500 schemes is invested today. But the annual Purple Book of scheme data does show a couple of charts indicating that the smaller the scheme, the greater the allocation to (especially UK) equities and the smaller the allocation to bonds.
If we assume that the simple average (rather than asset-weighted) asset allocation of the 5,131 private sector defined benefit scheme universe is a reasonable proxy for the asset-weighted allocation of the smallest 4,500, we can compare this to the PPF’s own asset allocation.
To zoom in, click the control at the top labelled “Productive Assets Only”.
The PPF’s allocation to illiquids is higher than our proxy for the 4,500 small schemes. But the PPF’s overall allocation to Productive Assets (if we include listed equity) is lower.
If small schemes consolidated under the PPF’s asset allocation it seems reasonable to expect new illiquid investments would be financed by sales not of bonds, but of public equities. There’s nothing necessarily wrong with this, but it surprised us to see nonetheless that the proposed public consolidator solution could be to sell around £28bn of stocks (including £7bn UK stocks), decrease holdings of ‘productive assets’ by around £7bn, and buy bonds.
So who’d backstop a PPF superfund? That’s a second, not insubstantial question we’ll consider in the next post.