Jeremy Hunt is playing fund manager with our pensions – and he’s terrible at it
Philip Pilkington
Updated 5 min read
Jerome Powell, chairman of the US Federal Reserve, from left, Jeremy Hunt, UK chancellor of the exchequer, and Elisabeth Svantesson, Sweden's finance minister - Samuel Corum/Bloomberg
The Chancellor of the Exchequer has announced that he is going to overhaul the pension system. Jeremy Hunt points to reforms in the pension systems of Australia and Canada and says that Britain is falling behind.
His main objection to the current defined contribution regime is that it is too risk averse and, for this reason, gives British people investing their pensions too low returns.
If you are invested in a pension fund in Britain and you possess some financial knowledge you may be frustrated at the limited options on offer.
Insofar as Hunt’s reforms aim to give savers more choice as to what they invest in, they should be lauded.
The British people are not children, many are knowledgeable about financial markets and invest their own savings, and there is no reason not to allow them to do the same with their pensions.
But it is not clear that this is what Hunt’s reforms are aimed at.
The Australian and Canadian systems do not so much allow savers more choice as to where to place their pension pot as they do allow large asset management companies to take more risk with peoples’ money.
In Australia, for example, the pension market is dominated by so-called “supers” – massive asset management behemoths that invest in everything from stocks and bonds to private equity funds and even directly into infrastructure projects and property.
This form of pension management on such a large scale is highly experimental, to say the least.
If you take a class in financial economics – or consult a financial adviser – they will tell you that by taking higher risk, you can achieve higher returns.
This is true – but only in a very abstract sense.
It is a result arrived at by academic statistical studies, but it does not always play out in practice. If you take too much risk, you are just as likely to lose your shirt as you are to get higher returns.
Your risky equity portfolio may pay out more in 10 years’ time than a less risky portfolio, but in the meantime, you have been riding an investment rollercoaster with the stocks you are holding rising and falling in sometimes scary ways.
While you watch your portfolio, knuckles clenched and white, the person invested in the less risky portfolio is sailing on smooth waters.
Perhaps Hunt is correct and British pension funds should take more risk, ride the volatility and achieve higher returns.
But the Chancellor should be aware that he is now playing the role of investment manager with his fellow subjects’ pensions. That raises the question of timing.
It is well-known that, in investment, past returns are not guarantees of future returns.
What is less well-known is that the longer the markets go on a winning streak, the more likely they will hit a wall in the near future and experience a losing streak.
The problem for the Chancellor is that this market cycle is now very long in the tooth.
More than that, it was premised on unprecedented central bank money issuance in the form of quantitative easing and zero interest rates.
Those days are now behind us, as inflation rages and the Bank of England aggressively raises interest rates. We are already seeing the effects of this on portfolios.
A standard British portfolio invested in 60pc stocks and 40pc bonds should achieve a return of around 7pc per year. In 2022, this portfolio lost 9pc as the central banks tightened rates and stocks and bonds fell.
If Hunt presses forward with the reforms and invests the country’s pensions in riskier assets only for the market cycle to sink into a downcycle, the result will be devastating not just for the Chancellor but for the Conservative Party.
Hunt will be put in the position of the giddy investment manager who promised his client too much, while the Conservative Party will have their reputation for sound management of money tarnished.
Labour will sail in and criticise the party, accusing them of financial market adventurism and playing the casino with the country’s savings.
Angela Rayner's recently rubbished calculations over the years it would take to benefit from Tory pension tax cuts would be a mere footnote in the reams of analysis and reproach of UK pensions policy would elicit in 2023.
Even if the riskier investments do end up paying off in the long-run, the short-term volatility could wipe out the government’s credibility.
As the British population ages, the pension system will come under increasing strain. The reality is that for a pension system to work properly there must be enough working-age people to pay into the scheme so that the retirees can extract the money they need to live.
Beyond this, in a society where the population is getting older huge pools of capital accumulate that need to be invested.
As this capital pours into the financial markets, it bids down the returns on assets. An aging society is one in which the iron laws of the market drive down returns.
Increasing the amount of risk that we allow our pension funds to take may alleviate this problem somewhat, but it will not solve it.
The only real solution to this problem is to reverse the dismal demographic trends that have been in place in this country for half a century.
Put frankly, people need to have larger families than they presently do or there will not be sufficient workers to take care of them in the future.
In the meantime, allowing our pension managers to play the riskier table brings with it enormous political and financial risks of its own.
Perhaps Hunt’s reforms are the right thing to do, but looking at the fragility of markets now is not the time to do them.
If the Chancellor wants to play investment manager with the country’s pension system, he had better make sure to get his market timing right.
