The new Labour government has extensive plans, which will need capital, to govern a country that already has a large debt burden.
Discussions are therefore under way on whether private sector investors could provide some of the capital required.
The last Conservative government saw similar issues ahead and so came up with the Mansion House agreement to try to address it.
In this, the country’s largest defined contribution pension fund providers such as Legal & General, Scottish Widows, Aviva and Phoenix committed to investing at least 5 per cent of their funds to unlisted equities by 2030. This could raise up to £50bn of new capital for the UK market.
Local authority pension schemes may take their private equity holdings up to 10 per cent, which would be £36bn of new capital.
To what extent might these initiatives provide the government with the capital it needs, and what might investors bear in mind if these changes take place?
Why did UK pension funds sell down their equities?
Let’s start with the recent history of defined benefit pension investment in UK equities.
According to a recent report by think tank New Financial, in 1997 UK pension schemes allocated 73 per cent of their assets to equities, today that figure is 31 per cent.
Over the same period the portion of assets allocated to UK equities has fallen from 53 per cent to 4.4 per cent.
International comparisons are hazardous as all pensions laws are complex and different in detail, but the US allocation to domestic equities is 44 per cent and in the quite similar Australian system the domestic equity allocation is 24 per cent..
The reduced allocation to equities seems to stem from a number of changes over the past 25 years. DB pension schemes have liabilities that last as long as the pensioners live, so increased life expectancy put a huge strain on these structures.
In 1955 British citizens on average lived until they were 70-years-old, now we expect to live until we are more than 80. Furthermore, on the asset side of the balance sheet, UK gilt yields kept falling through the period – from 5 per cent in 2000 to below 1 per cent just before the pandemic.
These increased liabilities led sponsoring companies to increase contributions to top up their pension schemes. Furthermore, in 1997, accounting rules changed with the introduction of FRS17.
This rule required the deficit in any DB scheme to be shown in a company’s balance sheet as a debt. Many in the City campaigned that this exaggerated the liability – the ‘net present value’ of the deficit was not something you have to pay today in cash, whereas when a loan becomes due, you do, so the two should not be shown as equivalent.
Yes, the notes in the accounts allowed the diligent to separate the two and to interpret the liabilities more accurately, but many finance directors took a more cautious view.
