The ultimate risk-taker – the state itself – could give UK pension funds a real boost, writes Joseph Mariathasan
There is an increasing level of interest in the UK about the idea of setting up a UK sovereign wealth fund, with the House of Commons debating the idea on 14 December. One of the briefing papers for the debate was an article I wrote in 2012 for IPE. In the article, I suggested that, given an ageing population, the UK should set up a sovereign wealth fund to add to tier-one pension provisions.
As MPs pointed out in the recent debate, there is an issue of inter-generational fairness when it comes to allocating resources within a country. An increasing ageing population cannot expect to rely on the Ponzi-type economics of taxing a declining younger population for future pensions.
I suggested that the existence of ultra-low Gilt yields did give the UK government one attractive option – that is, to issue a large amount of long-dated Gilts and invest the proceeds in emerging market equities that actually have higher dividend yields than bond yields. The dividends would, in effect, be produced by younger populations outside the UK.
Considering that Gilt yields are even lower in 2016 than they were in 2012, the attractions of such a policy are even greater, as the running yield is now even higher. It would, of course, be a state-owned hedge fund in effect but with the proviso that the state can always print more sterling if the assets become less than the liabilities.
The debate and discussion on the idea of a UK sovereign wealth fund encompasses a number of different strands. Will Hutton, president of Hertford College Oxford University and former editor of the Observer, and his colleagues at the Big Innovation Centre are arguing the case for a fund as a mechanism of creating greater long-term stakes in UK companies, to create more “purposeful” companies in the UK.
With 30-year Gilts yielding around 2% in December 2016, in the extreme case, the government could even look to issue perpetual-dated Gilts at not much more. Investing the proceeds in companies – with the explicit announcement that there would be no intention of ever selling – would be an attractive way of encouraging long-term stakes and also producing a running yield if the companies can pay dividends of more than running yield on the Gilts used to finance the investments.
There is another aspect worth considering as well. Pension funds are being effectively forced to invest in nominal and index-linked Gilts rather than equities despite the dramatic reduction in yields this entails. The reasons have been well discussed – some would argue it is a form of financial repression, driven by a mixture of accounting, regulatory issues and the underlying movement that has set in stone pension liabilities.
The net result is that matching pension liabilities is seen as a risk-management issue rather than an investment issue, so pricing of debt has become irrelevant. Pension funds are, therefore, unable to invest in long-term risky assets, whether in the UK or overseas, despite having long-term liabilities.
But the ultimate risk-taker in a country is the state itself. A UK sovereign wealth fund financed by issuing Gilts sold to UK pension funds would, in effect, be acting as an intermediary, guaranteeing pension funds the ability to meet their liabilities while generating much higher cashflows from elsewhere. Insurance companies are already developing attractive businesses buying out pension schemes and competitively pricing them through their own ability to take on additional investment risks. The sovereign wealth fund would be indirectly performing the same function.
At some stage, the fund could, of course, do this directly if it could issue debt with a sovereign guarantee. Imagine that – a sovereign wealth fund that hoovers up pension fund assets and reinvests them in risky long-term, but higher-return, investments while giving pension funds a guaranteed liability-driven set of investments.
Joseph Mariathasan is a contributing editor at IPE