Experts wary on BoE governor’s DC pandemic recovery call

In a speech to the TheCityUK group, reported by the Financial Times, Andrew Bailey said that business investment would be needed “on a much larger scale than we have seen in recent years”, and that DC pensions could be used to aid the recovery.

It’s important that the government doesn’t treat pension funds as a cash cow or attempt to sway trustees’ decisions unduly towards investing scheme funds disproportionately in line with government priorities

Steven Cameron, Aegon

However, Mr Bailey warned that existing regulations could be hindering the ability of DC schemes to invest in illiquid assets, preventing them from filling the role traditionally played by bank financing, which the governor said could not be relied upon if “excessive leverage” is to be avoided.

“While the current low level of interest rates supports the sustainability of UK corporate debt, higher leverage would make the corporate sector more vulnerable to interest rate or earnings shocks,” he said.

Mr Bailey’s speech comes at a time of heightened interest in using pensions to fund a national economic recovery. Last week, chancellor Rishi Sunak announced the UK’s first long-term asset fund — designed in part to encourage investment in illiquids by pension schemes — would be up and running within a year.

Meanwhile, campaign groups like Make My Money Matter, fronted by director Richard Curtis, have been pressing for pension schemes to involve themselves in a drive to “build back better” once the pandemic has subsided.

Pension schemes shouldn’t be seen as a national cash cow

Esther Hawley, principal at Barnett Waddingham, welcomed Mr Bailey’s move, telling Pensions Expert: “Removing some of the impediments to investing in illiquid assets in DC schemes is a good thing for DC members, as it will allow access to a wider source of returns.”

She noted that the Department for Work and Pensions’ recent consultation on changes to the charge-cap requirements should go some way to easing difficulties with performance fees, commonly used by illiquid funds and difficult to allow under the current charge cap.

However, Ms Hawley said that defined benefit schemes “do not face the same practical impediments to investing in illiquid assets as DC”, and yet “very few do actually have an allocation to, for example, infrastructure”.

“It seems unlikely that making these asset classes more available to DC will suddenly open up the levels of investment needed to boost our post-Covid economic recovery.”

Steven Cameron, pensions director at Aegon, cautioned that encouraging DC schemes to invest in illiquids “mustn’t take priority over the trustees’ key duty to act in the best interests of members”. 

He told Pensions Expert: “It’s important that the government fully recognises this and doesn’t treat pension funds as a cash cow or attempt to sway trustees’ decisions unduly towards investing scheme funds disproportionately in line with government priorities.” 

Daily dealing remains a problem

Despite welcoming the overall thrust of the BoE governor’s remarks, Mr Cameron highlighted certain structural problems that make illiquid investments more difficult for DC than DB schemes.

“Modern DC schemes allow their members to view the value of their pension pot, and switch between funds, on a daily basis,” he said.

“Furthermore, members have a legal right to transfer their pension to other schemes, and under pension freedoms can draw their retirement benefits at any time from age 55. Pension rules don’t permit the scheme to defer paying out, which does create issues if part of a member’s entitlement is invested in illiquid investments.”

Mr Cameron noted that the Financial Conduct Authority has been consulting on introducing mandatory notice periods to property funds to “avoid these having to hold large holdings in liquid assets to protect against a spike in encashments”, but warned that “this would exacerbate issues for [DC] pension schemes” and “could actually reduce their willingness to invest [in illiquids]”.

Maria Nazarova-Doyle, head of pension investments at Scottish Widows, agreed that daily dealing remains an as-yet-unsolved problem.

“The FCA is really concerned about [property funds] locking up and being suspended so often. So what they’re suggesting is to allow the manager to plan those withdrawals; the investors have to give them redeeming instructions up to 180 days in advance,” she said,

This throws up problems especially when DC funds have property as part of their default strategy, as default strategies are typically designed for daily dealing.

As a result, where as previously the conversation was about how to expand DC illiquid investments, “now we have a real risk of even losing the property that we had”, Ms Nazarova-Doyle said. 

However, if done properly, the relaxing of rules around DC illiquid investments could have a positive effect, she added.