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John Ralfe is an independent pensions consultant.

Does the answer to the UK’s chronic problem of underinvestment really lie at the back of the pension sofa?

Chancellor Jeremy Hunt thinks so, and in his Mansion House speech in July he outlined how defined contribution pensioners should invest 5 percent of their wealth in private equity, venture capital and start-ups.

Pensions experts have also had their say, suggesting myriad ways for occupational pension funds to invest more of their £1.7 trillion fortune in equities.

Unfortunately, pretty much all of these ideas are half-baked — they either misunderstand how DB pensions work, how financial markets work, or how fiduciary decision-making works. Some manage to misunderstand all three.

Still, something happens. The Government says: “There may be potential for the assets held by DB systems to work harder for members, employers and the economy.” A formal consultation has just concluded asking for opinions on two big ideas:

– Bring DB systems to it “Invest to get value” by switching from boring bonds and government bonds to stocks and other things “productive wealth”, Companies can withdraw cash under strict conditions.
— Set up a new one “Public Sector Consolidators” Soak up DB programs and invest in stocks/“productive assets” with economies of scale and expertise.

Let’s move beyond the government’s apparent belief that only listed and unlisted stocks are “productive assets” – even though corporations use cash from corporate bonds to invest in their companies and government bonds pay for all kinds of public goods – and us focus on the big picture.

Any attempt to coax or coax DB programs back into stock simply won’t work. We can’t repeat the ‘cult of equity’ like an ’80s sitcom because the nature of DB’s pension promises has fundamentally changed over the last few decades.

DB pensions with no guaranteed annual increase in inflation used to be effectively “with profits” – members shared the risk and reward of wealth development. Good performance meant a pension increase, poor performance meant no increase.

Companies held stocks lightly, as they only had to pay deficit contributions when assets fell below the modest value of the guaranteed annuity. “Discretionary” increases acted as a safety valve.

Guaranteed capped annual increases in inflation, coupled with significantly lower low real interest rates over the past 25 years, have fundamentally transformed DB pensions from with-profits to annuities. Nowadays, members no longer bear any risk in terms of risk and return of asset development.

Where stocks used to be the right asset, now fixed income and inflation-linked bonds are the right asset.

Matching pension assets and liabilities — holding bonds, not stocks — is common corporate finance, dating back 40 years to the great US economist Fischer Black. This was taken up by actuaries who applied these principles to the UK “Exley, Mehta and Smith“, in 1997.

Pension managers today — and I chair a small scheme — have no incentive to hold more stock. Our job is to protect pension promises.

To convince trustees to hold more stock, companies would have to start sharing outperformance again, for example by giving members a quarter of each annual stock outperformance. However, it doesn’t make sense to give away some of the stock’s gain and keep all of the loss — as companies are anxious to make up deficits.

If a company really wants to invest “with profits,” it should skip pensions altogether and simply borrow directly from its own balance sheet and buy shares. No company would ever decide to do this. So why should it be done indirectly via the pension fund?

“Investing for value” is just another form of covert leverage that never ends well.

If the government wants to encourage investment in certain sectors, it should continue to provide targeted tax breaks and not sledgehammer for pensions.

So what about the other proposals — giving companies the ability to withdraw cash from their retirement plans?

There is currently no mechanism in place to allow companies to do this until the annuities have been bought out. This is to protect members and prevent pensions from being treated as a (tax free) piggy bank: we should be very suspicious of any change.

And what do the members get out of it anyway? They inevitably lose out when an insurance company’s coverage date is pushed back.

Convincing the trustees to agree would require both a bank guarantee for the cash withdrawn in the event of insolvency and the company offering to compensate by increasing pensions. Businesses might as well borrow directly from the bank.

The government’s other big idea – “public sector consolidation” – is also full of loopholes. Here’s the big problem: The only guarantor of “public sector consolidation” would be government. There is nobody else. That would be a gigantic policy change. Why should taxpayers start guaranteeing hundreds of billions of pounds in private sector DB pensions?

If the government really wants a compliant pool of capital to invest in “productive finance” instead of guaranteeing private sector pensions, why not transfer all assets and liabilities to a new public sector pension scheme – like Royal Mail did when it was privatized in 2012 – so the? The state could then invest exactly as it wants?

Even simpler: Why not just issue government bonds and then invest directly?

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