£438 Billion. And Everybody Has Ideas About What to Do With It.

Britain is reorganising the investment of council workers’ pensions. The government sees an opportunity to help rebuild the country. But there’s an awkward question: whose money is it?

Britain has almost £438 billion sitting in pension funds for council workers and other members of the Local Government Pension Scheme. It isn’t sitting in a gigantic bank account gathering dust, of course. The money is invested in shares, bonds, property and other assets to help pay the pensions of millions of people. Nevertheless, whenever politicians see a sum that large, they tend to develop some rather ambitious ideas about what might be done with it.

Former Chancellor Rachel Reeves was particularly enthusiastic about reorganising these investments. Her proposals have since become law, and Britain is moving towards managing council pension investments through six large investment pools. The idea is partly borrowed from Canada and Australia, where enormous pension investors have acquired interests in everything from airports to electricity networks. The attraction is obvious: bigger investment operations can employ specialists, reduce duplicated costs and take part in projects that smaller funds might struggle to finance.

Why Is the Government So Interested?

Britain needs investment. Housing, roads, renewable energy, transport and infrastructure all require enormous amounts of money. Governments can borrow to finance these things, but borrowing costs money, and taxpayers eventually have to foot the bill. Pension funds, meanwhile, need investments capable of producing reliable returns over many years. It isn’t difficult to see why bringing the two together looks attractive.

A successful railway, energy project or housing development might generate income for decades while benefiting the wider economy. Everybody wins. At least, that’s the theory. The difficulty arises when a project that looks splendid in a ministerial announcement doesn’t necessarily look equally splendid to the people expected to finance it. An investment can be socially desirable without being financially attractive, and pension managers have to consider both the potential rewards and the risks.

The new arrangements give the larger investment pools responsibility for managing investments, while local pension authorities retain responsibility for setting their investment strategies. Those authorities must also set targets for local investment and consider regional economic priorities. This doesn’t mean the Treasury can simply take £438 billion and spend it as it pleases. But it does create a closer relationship between pension investment decisions and the government’s ambitions for economic development.

What About the People Whose Pensions These Are?

Here’s an important distinction. The Local Government Pension Scheme is a defined benefit scheme. A council employee’s pension is calculated according to the scheme’s rules, earnings and length of membership, rather than the daily performance of a personal investment pot. If the investments have a bad year, that doesn’t mean the employee’s promised pension suddenly falls by the same amount.

Unfortunately, that doesn’t make investment losses disappear. When pension funds perform badly, participating employers may have to increase their contributions to keep the schemes adequately funded. For councils already struggling with their finances, that can mean additional pressure on budgets, services and ultimately council taxpayers. Good investment management therefore matters to considerably more people than the pension fund managers themselves.

There is also a question about size. Larger organisations can save money and gain access to investments unavailable to smaller funds. But concentrating investment decisions in fewer organisations doesn’t automatically make those decisions better. Large investors can make large mistakes, and some infrastructure and private-market investments can be difficult to value or sell when circumstances change. Professional management and proper oversight matter rather more than the impressive number of billions under management.

The SpaceBuggy Question

There is a perfectly respectable argument for using British pension investments to help finance productive British businesses and infrastructure. There is an equally respectable argument that pension managers must be free to reject projects that don’t offer suitable returns for the risks involved. The two objectives needn’t conflict, provided investment decisions are made for sound financial reasons rather than political convenience.

And that brings us back to the original question. If the government has a promising infrastructure project, why shouldn’t a pension fund invest in it? Indeed, why shouldn’t investors from around the world compete to finance it?

But if a project cannot persuade professional investors that it makes financial sense, perhaps the answer is to improve the project rather than persuade pension funds to lower their standards.

After all, £438 billion is a magnificent sum of money. But it is pension money, not a spare Treasury account.