How can public sector pensions benefit the UK economy?

Chancellor Rachel Reeves recently suggested that pension funds can be used to “fire up the UK economy”. At the same time, the government launched a consultation on pooling the funds of the Local Government Pension Scheme (LGPS). 

The two ideas are connected – but what is LGPS pooling, and how can it be used to stimulate the economy? 

The UK is a world leader when it comes to pension assets. Altogether, there is around £3trn invested in British pensions, second only to the US. 

However, most of this is invested outside the UK. If more of that money were invested in UK assets, such as shares in UK businesses or infrastructure projects, British pensioners could still get investment returns on pension savings, but also provide extra funding for local investments or make them more competitive. 

The government is particularly keen to use the LGPS funds for this purpose. This is because they are public sector pension funds – meaning the government has more control over them than private pension funds. 

Pools and government plans

The LGPS is made up of 86 funds that manage their own investments, totalling about £415bn*. These funds allocate some of their money to one of eight LGPS pools, which are investment organisations set up exclusively for and by the LGPS. 

The government is proposing that LGPS funds should be required to transfer all their investments into these pools. These pools can invest more cheaply and efficiently than the constituent funds, which will benefit the LGPS itself. However, they will also become large enough to invest in certain things that the government is keen for them to invest in, which are only realistic for giant funds. 

Canada provides an encouraging example of what pooling could look like in the future. The chancellor recently held a roundtable with representatives of the Canadian ‘Maple Eight’ – large pension plans that are comparable to LGPS pools. 

The Maple Eight have consolidated such large amounts of money that they are able to drive down costs by taking advantage of economies of scale, and by employing their own dedicated in-house experts. LGPS pension funds currently rely on third-party expertise for many functions. 

Lessons from Canada?

The Canadian funds are also able to make the kinds of investments that are only viable for the very largest investment funds. These investments might include large-scale, long-term infrastructure projects like housing, energy, water, or transport. 

These projects can generate good returns, but take a long time to become profitable, so they are only viable for large funds that can afford to wait while they make money from other more conventional investments. 

The Maple Eight can also manage these investments more effectively, by having their own experts manage the investments internally and by making related investments so that they can become effective owners of these projects, rather than just investors. 

The government would like to see the LGPS consolidate and then become able to make these kinds of large-scale investments in the UK. 

What the LGPS needs

The consultation suggests that the LGPS would be required to invest 5% of its money in the UK, which would be about £20bn. This money could make a significant difference to the economy, but there is some reservation about this requirement. 

Requiring the LGPS to invest in the UK suggests, at least in theory, that it would otherwise prefer to invest abroad because it could get better returns elsewhere. Indeed, even in Canada, although Maple Eight funds do invest in the kind of projects that the government wants the LGPS to invest in, they do not necessarily do it in Canada. 

For this to work, the government will need to ensure that enough high-quality investments are available in the UK, and that the quota is not too high. If not, there could be market scarcity issues, where the LGPS has to accept bad deals, or can’t invest in a diverse enough range of UK assets. 

If these investments do poorly, the LGPS will need to pay to guarantee the pensions of their current members, which could mean an extra cost to the taxpayer or future LGPS members. 

John Upton is a policy analyst at the Pensions Policy Institute. 

* Estimate from Isio as of 31 December 2024.