Despite high levels of investment into infrastructure and other long-term projects, pension funds – both defined contribution and defined benefit – face a number of challenges. These challenges range from regulatory barriers and tax to availability of investment vehicles and structures.
However, it has become increasingly accepted that the ability to achieve scale can be an important factor in facilitating investment in productive assets by pension schemes. The need to channel long-term investment into all regions of the UK to fund low-carbon infrastructure and make tangible contributions to the real economy also needs to be addressed.
Throughout 2023, BNY Mellon has convened roundtables with industry experts to discuss these issues. At a roundtable in Manchester, featuring Mayor Andy Burnham, a range of industry representatives discussed what the UK can learn from Canada and Australia, and how the role of pension funds in the productive finance agenda can be expanded.
Consolidation of smaller funds is a common characteristic of both the Australian and Canadian models. This has contributed to the size of their largest pension funds, allowing them to benefit from operational and cost efficiencies. On the investments side, scalability is also conferred with improving the prospects for accessing opportunities in less liquid investments, making it more conducive to infrastructure investments.
The Canadian case
The consolidation and growth of Canadian pension funds has been facilitated by legislation. The Investment Management Corporation of Ontario, currently the eighth largest Canadian fund, was created by government edict in 2017 to provide investment fund services on behalf of provincial public pension boards.
More recently, a number of university pension plans came together by jointly transferring their assets and liabilities to establish the University Pension Plan. This followed changes to rules on the conversion of single-provider plans into jointly sponsored pension plans – a direct-benefit scheme that has become a dominant feature of the Canadian model owing to its independence and risk-sharing properties.
Benefits from economies of scale have become synonymous with characteristics of successful pension funds. While continuing to harness third-party expertise, the Canadian model champions the internal capacity built by its larger funds. Consolidation has made it efficient to develop in-house expertise, reducing costs from external managers while assisting funds with greater access to investment opportunities in riskier asset classes. Another consequence of this expectation is an emphasis on talent, where the impact of intra-fund competition in remuneration has contributed to talent retention and improvements in supervision.
The Australian case
A central feature of the Australian pension landscape is the superannuation system. Funds pooled their management and infrastructure investment programmes in IFM, an investment company collectively owned by the pension funds. This created sufficient scale to develop the asset class, which became a significant holding in many funds. This enabled the funds to develop a centralised expertise for investing in the asset class where no fund at that early stage had sufficient scale to build that skill. In addition, the owners of the collective ensured a favourable fee environment.
As the sector grew, the company began to take on more global clients (at higher commercial fees), which then funded the expansion of its global asset management expertise. The initial Australian funds also developed in-house expertise and began to invest directly in infrastructure, either in partnership or competition with the initial collective company.
With the Australian system now holding over $3tn of assets and the major funds merging into larger entities, infrastructure investment has become more global. Foreign investment in Australia has increased in the past decade, making the competition for assets greater while also allowing the government to use this pool of domestic and offshore pension savings to recycle new and existing infrastructure assets back to pension funds in the secondary market.
Another key factor in encouraging infrastructure investment is the role public sector guarantees play in encouraging pension funds to consider productive investments at an earlier stage.
Because the Australian market has scale and the existing pool of assets are invested for the long term, the exposure to infrastructure is relatively high – in the range of 5%-10% for most major funds with largely stable or growing asset pools. While competition between funds has increased, and members are able to move funds more easily between superannuation funds, the exposure to illiquid assets has remained relatively high due to the overall fund stability of assets.
Australian governments have used this available pool of assets by selling existing and new infrastructure to funds in the secondary market. Once sold, the government often reinvests these proceeds into further infrastructure, recycling capital from initial government investment into long-term savings pools. Superannuation funds are typically more cautious in undertaking initial development investment in infrastructure, and they allow the government to take the development risk. Regulators are increasingly focused on ensuring funds have sufficient liquidity to manage cyclical or structural downturns, but this has generally not altered the funds’ desire to hold illiquid assets such as infrastructure.
The importance of scale
While the unique composition and context of domestic pensions will influence how this needs to work in practice, the UK is able to draw lessons from the approaches taken in Canada and Australia. However, it is imperative that any pension reforms aimed at facilitating greater levels of productive capital ensure that the ultimate goal of pension provision continues to be that people can live well in retirement and this means that investment portfolios will continue to need to be appropriately diversified across asset classes and geographies/economies. The challenge lies in ensuring a UK focus on productive finance is a win-win initiative with pension funds benefitting from the potential that productive finance has to offer in delivering returns, while also contributing to socially productive outcomes.
Efforts to achieve scalability through asset pooling have already commenced in the UK. In 2018, local government pension funds began to consolidate more than 80 funds into eight asset pools. Transition speeds have varied, with fund sizes ranging from £16bn-£60bn, composed of the funds’ more liquid assets. Further consolidation is planned in the coming years, but the current trajectory is insufficient to replicate the benefits seen in Canada and Australia.
The UK’s chancellor of the exchequer has committed to taking forward a series of reforms aimed at facilitating pension fund investment in productive finance and BNY Mellon will be closely monitoring these developments. If calibrated correctly, these initiatives could play an important role in unlocking capital for investment in productive assets such as infrastructure, though it is essential that any resulting reforms continue to prioritise retirement outcomes for pension scheme members.
OMFIF editors in association with BNY Mellon.
Read ‘Infrastructure Investing and UK Pension Funds: Navigating LTAF and Productive Assets’ here.
OMFIF’s 2023 Global Public Pensions report will be launched 30 November 2023. Register here.