The dangerous rise of pension nationalists

Rachel Reeves, Britain’s new chancellor, says that she has inherited the worst fiscal circumstances since the second world war. An exaggeration, perhaps, but only a small one. To address the squeeze, Ms Reeves will seek the help of Britain’s retirement savings. On July 8th she said that she wants the country’s pension funds “to drive investment in homegrown businesses and deliver greater returns to pension savers”.

Details of Ms Reeves’s plans are still to emerge. Her predecessor, Jeremy Hunt, set the ball rolling by mandating that defined-contribution pension funds will have to disclose the scale of domestic investments by 2027. Other countries are joining in. Stephen Poloz, a former governor of the Bank of Canada, is looking at how to increase pension-fund investment in domestic assets on behalf of the Canadian government. Enrico Letta, a former Italian prime minister, recently argued in favour of an EU-wide auto-enrolment pension scheme that could be funnelled into green transport and energy infrastructure.

What explains the rise of pension-fund nationalism? Many Western countries, other than America, face similar problems. Politicians fret about low levels of business investment. The most promising high-tech firms flee for Silicon Valley when seeking venture-capital funding or Wall Street when requiring a stockmarket on which to list. High interest rates and mighty government debts mean that cash is scarce. Time, then, to shake down pension funds.

There may be some measures that pension-fund nationalists are able to employ without dampening returns. Removing barriers that prevent funds from investing in domestic assets is a laudable enough goal. In Britain small private-pension plans could be consolidated, which would allow for economies of scale and make investing in private markets more straightforward.

Research by Keith Ambachtsheer, Sebastien Betermier and Chris Flynn, a trio of economists, shows that Canadian funds invest a disproportionate amount at home when it comes to bonds, property and stocks. But they invest relatively little in domestic infrastructure as the government chooses not to make such assets available to them. The authors propose that the Canadian government follows the example of countries including Australia and India, which have made their infrastructure an asset class in which pension funds at home and abroad can invest.

Yet savers have reason to be sceptical that extra domestic investment will produce higher returns. Pension funds already exhibit home bias, deploying more cash to local markets than would be best. Over the past decade, the msci Canada and Britain indices have returned 4% and 3% a year in dollar terms, while American stocks have returned 13%. Any Briton or Canadian who wishes their pension allocation was more domestic is a truly selfless patriot. And the two markets have not underperformed because they are capital-constrained. They have underperformed because they are stuffed with companies in industries such as banking, energy and mining, which have lagged behind America’s soaring tech stocks.

Enormous East Asian retirement piles provide a valuable lesson in the merits of pension globalism. The governments of Japan and South Korea once deployed state pension funds in pursuit of national goals, as Western politicians are now discussing. But in recent years they have changed approach, prompted to do so by worries about ageing populations and low returns. As recently as 2010 more than two-thirds of assets held by both the Korean National Pension Service and Japan’s Government Pension Investment Fund were domestic bonds. Today the share has fallen to 30% and 27%, respectively. Both countries are investing more overseas and in riskier assets. As a consequence, returns have surged.

Few Western politicians would like to go as far as the Japanese and South Korean governments once did, but the direction of travel is nonetheless worrying. Giving pension funds more options is one thing. Limiting their options in order to encourage domestic investment is quite another. That is especially true given that governments already face a formidable challenge when it comes to providing for baby-boomers during their increasingly lengthy retirements. National obligations that lower returns will inevitably leave governments holding the bag for any shortfall in the decades to come. When that happens, they will rue the decision to have focused on anything but making money. ■

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