What Britain Can Learn from Canada About Pension Funds

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The author of this article is a contributing editor to the FT.

When analysing the shortcomings of the British pension system, one place that often gets the spotlight across the Atlantic is Canada and its giant pension funds, which have emerged as a major force in international finance, particularly in managing private wealth directly.

The plan to encourage investment in the British economy and prevent withdrawals from domestic stocks hinges significantly on merging pension funds to resemble Canada's. But will this solve Britain's problems? Looking at the two countries, the unification of Canada into Britain is complicated.

Some of the problems of the two economies actually look similar. UK GDP per hour has grown by a paltry 0.6% annually since 2015, about half the rate in the US. Canada’s productivity growth has been almost as abysmal.

Expert consensus in both countries points to a lack of domestic investment as the cause of the problem. In late 2023, more than 70 UK business leaders wrote an open letter to Chancellor Jeremy Hunt, complaining that pension funds were draining UK capital and urging him to do more to reverse the decline in domestic stock pension investment. A few months later, 92 Canadian business leaders sent a similar letter to Canada’s finance minister.

This problem occurs despite the fact that both countries have huge amounts of funds in their pension systems. The demand for increased domestic investment must be proportional to the opportunities available. And this is where some of the differences between the two countries lie.

While Britain has provided major airports, power grids, water and waste networks to private funds, there has been little opportunity for Canadian pension funds to invest in their own critical infrastructure. For example, when investment opportunities arose, the pension funds that funded and built the Montreal subway system invested. You can’t blame the Canadian system for not trying. And capital has flowed into British infrastructure regardless of nationality.

However, the UK’s ability to deliver new investable projects to meet potential regional demand is questionable. Earlier this year, a report by the Purposeful Finance Commission, a regional government forum, suggested that regional planning expertise was so lacking that investors should band together to fund additional planning officers to clear the backlog of applications. The newly unified UK pension fund could struggle to allocate new funds to UK infrastructure investment. Like their Canadian counterparts, UK policymakers need to focus on supply as much as demand to stimulate investment.

The problem in the area of ​​capital for growth companies is not UK supply. The UK does not suffer from a shortage of high-quality early-stage companies. The UK has become the largest European hub for venture capital and growth equity, raising more than the next largest markets combined, even without domestic pension capital. The problem is that there is not enough capital to support growth companies as they scale. Integrating the system would allow more allocation to risky venture capital investments, which tend to deliver high long-term returns for investors and the economy.

The picture is not so bright for UK listed equities. Even if UK pension funds follow the Canadian path toward consolidation, it is unlikely that this will be a panacea for UK listed equities by significantly increasing their strategic allocation to them. The global trend is to invest globally due to concerns about concentration risks due to domestic bias.

But the idea that UK companies have a higher cost of capital because of a reduced home bias is controversial. Keith Ambacher, emeritus director of the International Pension Management Centre, argues that global changes are not making it harder for domestic companies to access capital. Canadian and UK pension funds are shifting away from domestic stocks, he says, but so are funds in Australia, Europe, the Middle East, Singapore and other countries. The situation is balanced.

Consolidating the funds would open up a cheaper way to allocate to so-called productive finance. And given the massive tax credits available to pension savers, it is only fair that the Treasury should have some say in where pensions are invested if it so chooses. But if left to its own devices, the shift away from domestically listed equities is unlikely to stop or reverse anytime soon.

Video: How to reboot the UK's capital markets | FT Film

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