Onward In-depth: Why British pensions aren’t investing

Allan Nixon

Head of Science and Technology at Onward

Onward In-depth is a new regular newsletter directly from our team, giving you a deeper insight into our research.

British pensions aren’t working for savers or science. Despite having the largest pension market in Europe, UK funds are only responsible for 10% of venture capital compared to 72% in the USA. The largest schemes here invest 15 times less in start-ups than Canada’s biggest, nine times less than the USA’s and nearly four times less than Australia’s. It’s no wonder young cutting-edge firms move abroad to grow.

This chronic underinvestment is typically blamed on the idea that venture capital offers poor value for investors. This clearly isn’t the case. In fact, Onward’s latest research shows that savers could add £98,000 to the average pension pot if pension schemes invested in so-called’ growth capital’.

So why are UK pensions failing to invest? There are three key obstacles.

Barrier One: Consolidation

The UK defined contribution (DC) market is too fragmented with too many small schemes unable to invest in venture capital because they lack the expertise and knowledge of larger schemes.

While there has been a focus on consolidating these small funds, progress has been slow. There were still almost 27,000 different DC pension schemes in the UK at the beginning of 2023. Of these, more than 25,000 had fewer than 12 members. At the rate of consolidation since 2016, it will take another 25 years for all of these ‘micro’ schemes to wind up.

Barrier Two: Culture

Lack of scale does not alone explain why the UK’s largest pension funds refrain from investing in growth capital. Regulatory or operational barriers are not to blame — it’s cultural aversion.

Pension funds have an excessive focus on keeping costs down even at the expense of return on investment. Pension funds pay fees to financial institutions and advisers who handle their savers’ money, with the annual fee for firms’ most popular products capped by law at 0.75% of total assets. Fees for growth capital tend to be higher than other asset classes. As a result, pension funds being focussed more on keeping handling fees down than on returns can prevent these kinds of investments.

Another issue is ambition and benchmarking. UK pension funds starkly underperform relative to international peers, but they do not benchmark themselves against them. The average large pension fund in the US, Canada or Australia has delivered annual growth over the past five years that is 56% higher than their UK equivalents, with the UK averaging 4.4% growth per year compared to an international average of 6.9%.

Even if UK pension firms had performed as well over the past five years as their targets, their growth rate would still trail the average large Canadian, US or Australian pension by more than 2 percentage points per year.

Barrier Three: Capacity

Finally, unlocked funds must also actually find their way into the hands of high-growth firms seeking investment. But despite being the largest in Europe, the UK venture capital industry is significantly smaller than the US (even adjusted for the US’ larger economic size).

Even if the barriers described above were overcome with ease, capacity would still need to be built within the VC industry to handle this large influx of investment capital.

The failure of the UK’s pension funds to invest in our world-beating science and tech sector is perhaps the single largest barrier to the Government’s ambition of becoming a scientific superpower. The UK’s innovators, scientists and entrepreneurs cannot afford any more delay in finding the funding they need.

If you want to read more about why Britain’s pensions aren’t investing and how we can get schemes investing, helping start-ups and savers, read Onward’s latest report by Zachary Spiro, Pension Power.