Investing in the just transition through UK businesses can boost the economy, help the planet and improve pension outcomes, argues the Finance Innovation Lab’s Jesse Griffiths.
Are UK pension funds investing effectively? The short answer is: no – not for savers, not for the economy, and not for the planet.
Pension funds, collectively managing more than £2.5trn in assets, are investing less in the UK than they once did, and far less than they could.
Defined benefit (DB) schemes – which still hold the majority of assets – have maintained strong UK exposure over the past two decades. But the nature of that investment has shifted dramatically.
Once heavily invested in UK equities, DB schemes have retreated into safer, lower-yielding assets like bonds. UK equity allocation has fallen from 32% in 2006 to just 2% today, government numbers show.
Defined contribution (DC) schemes, meanwhile, are increasingly the norm for today’s workers. They have turned sharply away from the UK: from 55% of assets invested domestically in 2012, to just 22% now, according to government data.
Critically, both models have weak risk tolerance and short-term horizons – DB schemes because they are winding down, and DC schemes because they individualise risk, forcing savers to plan for worst-case scenarios.
Is CDC the solution?
It is no surprise then that pension funds are barely participating in the UK’s green transition. Just 4% of all UK pension fund assets are invested in climate solutions, according to Phoenix Group. In the face of an existential climate threat, this is indefensible.
What’s needed is a change in structure and strategy. The government is right to champion collective defined contribution (CDC) pension schemes, which pool longevity and investment risk across members. CDC schemes can support longer-term, higher-return investments in a way individualised DC schemes cannot.
One estimate is that CDC pension schemes could deliver retirement incomes around 50% higher than traditional DC for the same contributions.
Just as importantly, they could be a powerful vehicle for investing in the real economy and sustainable infrastructure. International evidence supports this: collective pensions in Canada and the Netherlands achieve better returns for members while allocating more to long-term, illiquid assets – exactly the kind of investment the UK economy is crying out for.
But pensions are only part of the story. The deeper issue is a failed financial system.
Fixing the UK’s financial system
Despite having one of the world’s largest financial sectors, the UK consistently ranks at the bottom of the G7 for business investment. The numbers are startling, and it’s not just the pensions system that is failing.
In 2023, just £4bn was raised via UK stock markets for primary capital, according to New Capital Consensus, compared to £87bn paid in dividends and £35bn in share buybacks. Bank lending to small firms has fallen 14% in real terms since 2014.
We need a new approach to financial sector policy that treats finance as a means to deliver economic, environmental and social goals. That means reforming not only pension structures, but also building the institutions that support long-term investment.
One clear step is scaling up the UK’s National Wealth Fund. Last year, its predecessor, the UK Infrastructure Bank invested just £1.7bn in the UK – barely a rounding error compared to Germany’s equivalent institution, KfW, which invested £68bn in Germany.
If designed properly, a UK fund could aim to reach a similar scale, over time, by issuing green bonds that pensions could invest in, creating a safe, liquid route into productive assets.
Ultimately, what’s needed is ambition. The organisation I lead, Finance Innovation Lab, is part of a growing coalition of civil society organisations and trade unions calling for reforms that would deliver decent pensions for all, scaled up investment in the UK’s just transition, and a phasing out of investments in fossil fuel expansion and deforestation.
If the government is serious about a major review of the pensions system, it must include the voices of savers, workers and civil society in its review – and keep its eye on the real prize: a pensions system that delivers for people, planet, and the UK economy.
Jesse Griffiths is the chief executive officer of the Finance Innovation Lab.
