Delivered earlier this month by Chancellor Jeremy Hunt, the much-anticipated Mansion House Speech was, arguably, a bit of a damp squib. The ideas sounded good at face value - who doesn’t want higher pensions for all, better funded British businesses, lower price inflation, and more innovation?? And some of the reforms should indeed help, particularly simplifying regulations and making the London Stock Exchange accessible to more businesses. The Chancellor rightly recognises diversification as a lower risk approach to investing but could mislead many to think that the £1000 extra pension is guaranteed when it’s not, and he seems to have found the holy grail to investing: more return with less risk!
Let’s look at the wider economic environment:
The Chancellor is correct in saying that high price inflation is holding the UK economy back, it creates distortions in the economy and supply chains, increases wealth inequality, and makes consumer and business decisions more uncertain. It’s a shame that the Chancellor and the Bank of England have not yet been willing to admit their responsibility for the primary reason for rising prices, which is their increase in the money supply. Both the money supply and prices are up by around 25% since the start of 2020.
The Chancellor reiterated that he and the Bank of England will do “what is necessary for as long as necessary to tackle inflation persistence and bring it back to the 2% target”. There are only two realistic ways to achieve this goal given where we are: to reduce or cap money supply growth thereby creating a recession, or cap prices rises for goods and services within the CPI measure to push inflation into the prices of those items not measured. Both methods are destructive to real peoples’ lives: this is Jeremy’s unavoidable dilemma.
He said he wants to “deliver sound money” but is still willing to accept a 2% per annum inflation target. Truly sound money would be asset, not debt-based, and have a fixed supply which over time would be able to buy more goods and services so that all members of society could benefit from economic growth.
If the Chancellor is indeed serious about fixing the economy and pensions/savings, then he needs to start by fixing the money which underpins all investments and business planning. Without that, we are building on quicksand.
Now let’s look at Pensions:
The new superfund regime sounds interesting, and innovation should be encouraged. However, there is a risk that by being so keen to see fast consolidation there is an inadvertent sharp rise in systemic risk within the financial system. After the Bank of England’s clumsy actions last autumn (from which the Government made a £4bn profit at the expense of defined benefit schemes), can the Bank credibly be trusted to spot and mitigate systemic risks? Superfunds can supplement the existing insurance regime, if they can price competitively enough!
One nuclear option to achieve the Chancellor’s growth aims would be for the Pension Protection Fund to guarantee 100% of some or all UK defined benefit pensions. This would allow schemes to invest in higher risk growth assets knowing that if they didn’t perform members could still get their benefits. However, this could encourage a significant shift out of gilts so the Bank of England would need to step in to bail out the UK government bond market, and significantly increase complexity and counterparty risk (which is fine, until the next tail risk event!).
The reforms aim to increase investment returns by encouraging investment in start-up companies and illiquid private equity. Whilst long-term returns may be higher than alternatives, these asset classes come with more volatility and risk. Do we want the UK government to decide our risk preferences based on their political goals?
The Compact is voluntary and a 5% allocation doesn’t sound much, but if these investment ideas are so good why are they not already used? There is a high risk that once the threshold is set it is made mandatory and increased for political reasons rather than investment reasons.
There is talk of simplifying regulations. This is probably welcome (although we don’t yet know the detail) as it could reduce barriers to entry and increase competitiveness to improve future investment returns, but be alive to new risks to investors.
What does the Chancellor think that pension schemes should sell to buy these riskier growth assets? He is clearly worried that gilts will be sold putting pressure on the government’s finances. A tricky balance if high price inflation remains sticky…
The proposed value-for-money test will need to calculate investment performance net of costs. Whilst it is common sense, the disclosure requirements will add costs and could encourage cherry picking of funds which have recently performed well but may not do so in the future. This could herd investors to buy high and sell low, the opposite of what they should be doing.
In conclusion
There were a lot of political soundbites and the industry has been hit with another round of consultations creating more time-consuming uncertainty. Ultimately, whilst top-down political solutions are tempting (“at least someone is doing something!”) they are not sustainable precisely because they are top-down and political. We await the detail, the sugar high, and the fall-out.
Sam Roberts, Director of Investment Consulting at Cartwright
