The government should carefully consider any intervention in domestic pension scheme investment and identify the specific ‘market failures’ it intends to address, a joint report from Frontier Economics and LCP has argued.

The UK pension schemes and productive finance – a framework for effective intervention report argued there was no clear case for the government to override trustees’ judgments when acting in member interest, or to set top-down targets for total levels of ‘productive’ investment.

It highlighted there were big differences in investment strategies between UK and other countries’ pension systems, and the government was urged to move away from “spurious” comparisons with other countries’ systems when deciding what was right for the UK.

Furthermore, as UK pension schemes grow, they will tend to diversify by investing in the types of assets the government wants to promote without being forced to do so, the paper stated.

Policy should identify the ‘market failures’ the government wants to address through pension investment, the report added, and just because schemes in other countries allocate a certain percentage to domestic productive assets, it did not necessarily mean this was the right answer for UK schemes.

Therefore, before intervening, the government was urged to identify what market failures it wished to tackle, in line with best practice, such as environmentally beneficial investments.

The report noted that investors could struggle to assess risks and returns associated with certain types of investments, or that ‘coordination failures’ could lead schemes to be wary of being the first to invest in higher cost investments.

While the report said there might be a case for government intervention in these types of issues, it would need to be confident that it had the appropriate capacity and information to make an assessment.

Measures to drive up scale were likely to reduce barriers to investing in private markets and infrastructure, but much of this scale-up was already happening, LCP and Frontier Economics said.

The report noted that the creation of Long-Term Asset Funds had the potential to reduce barriers to illiquid investments, and backed the proposed freedom for pension providers to move poorly invested or under-performing group personal pension policies into more modern and productive investments.

However, it argued that the case for giving schemes value for money ratings, grouped into four categories, was less clear, and there was potential for this to lead to herding behaviour as schemes were reluctant to stand out from the crowd, which could reinforce a coordination market failure.

Overall, the report authors said they did not support the power being taken by the government in the Pension Schemes Bill to potentially ‘mandate’ defined contribution (DC) pension schemes to invest in private markets if voluntary commitments to the Mansion House Accord were not met by 2030.

“The UK’s growing DC pension sector is a great success and potentially a huge benefit for the economy as well as for future pensioners,” commented Frontier Economics senior adviser, Paul Johnson.

“Any government intervention in how those funds are allocated needs to be very carefully assessed.

“We need a rigorous framework to assess value for money, making sure that interventions are laser-targeted on areas where market forces alone will not deliver the right outcomes.

“The appropriate interventions will depend on the specific market failures we need to tackle and not on some arbitrary top-down target. Governments should act with great humility for fear of reducing the value of people’s pensions.”

LCP partner, Steve Webb, added: “We need to move away from spurious comparisons with the pension systems of other countries when deciding what is right for the UK.

“The Australian DC system in particular is currently far larger and far more mature than the UK system and this will inevitably lead to a different investment mix compared with the UK’s smaller master trust sector.

“The UK investment mix will in any case shift rapidly in the coming years, as UK DC schemes grow rapidly, and the government should not be in the business of over-riding trustee decisions to impose what it thinks is the right answer.”

Last week, the government looked to assuage fears from the pensions industry over the reserve powers included in the Pension Schemes Bill on pension scheme asset allocation, highlighting that the powers were designed to serve as a backstop to the Mansion House Accord commitments and that it did not intend to need to use them.

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