Pension funds should invest in Britain
The British economy remains strong – low unemployment rates, robust inward investment and the strongest economic growth of the G7 since 2010 all bode well. Our political system - led by a Prime Minister who imbues competence, integrity and compassion - is robust.
Not many countries could have changed the head of state, the head of government twice and navigate a global economic crisis in short order, with barely a flicker of public unrest.
Of course, challenges remain. Converting the sound economic record into higher living standards will require faster growth to allow the tax take to meaningfully drop – a global conundrum. But the solution to others could be easier to solve.
One of the Chancellor’s key growth areas is Financial Services and the Edinburgh Reforms start to address some of the hurdles to faster growth. However, much more can be done.
In my Budget speech on 21st March, I spoke about the importance of the City, which generates more than 10% of Britain’s GDP. There are signs that our stock market is ailing – chip designer ARM and building materials giant CRH, which together account for £80 billion of market worth, have shunned Britain for listings in the US.
This should concern us, as the stock market acts as a gateway to other financial services, such as derivatives, trading, insurance and legal services – whose well-being (or lack thereof) also has consequences for the wider economy. We should perhaps ask ourselves why so many of our start-ups were banking with Silicon Valley Bank.
A key part of the problem is that our pension funds, the big beasts in the City, have in recent decades adopted a far more defensive approach to investing, particularly after the financial crash of 2008/9 – shunning equities in favour largely of bonds and other assets. This was not replicated in most other developed economies, and this is having a knock-on effect across the financial landscape.
According to the Capital Markets Industry Taskforce (CMIT), which has been researching the UK’s financial ecosystem, in 2000 39% of all shares listed on the London Stock Exchange (LSE) were owned by British pension funds. By 2020, this had dropped to just 4%. As such, the LSE has lost its biggest source of capital.
Our pension funds’ reluctance to invest in equities is not replicated by pension funds based abroad. British pension schemes now only hold 27% of their investments in domestic and global equities, compared to 50% in the United States. Instead, our pension funds hold 72% of their investments in fixed income, real estate and other assets, whereas these account for only 32% of their counterparts’ investments in the United States.
According to one of the witnesses at a recent session of the Treasury Select Committee, in 2021 a single Canadian pension fund invested more in one British private company than all our pension funds invested in British companies in the same year. Our pension funds’ caution helps to account for the UK market’s lowly rating relative to others and is one reason British firms are notoriously liable to fall into foreign ownership.
In total the British pension pot accounts for some £4 trillion, amounting to the second-biggest pot in the world. If even a small portion of this was diverted to the British stock exchange, many companies would benefit (especially in their early funding cycles), and this would ensure that more successful firms retained their financial home in Britain.
The Financial Times recently highlighted the case of Immunocore, a British biotechnology firm pioneering the next generation of treatments for cancer, viral infections and autoimmune diseases. Unable to secure sufficient funding in the UK, it listed on the Nasdaq in 2021 where its market capitalisation now stands at $2.6 billion. Immunocore is one of many UK firms whose excellent long-term prospects accrue benefits not to the UK, but abroad.
The reasons behind the reluctance of British pension funds to invest in British equities are mixed, but according to CMIT’s analysis the most significant reason is the profound shift in Britain away from Defined Benefit (DB) pension schemes in favour of Defined Contribution (DC) pensions.
Companies began to close their DB schemes to new entrants over concerns around the cost of employer contributions. With no more contributions forthcoming, schemes de-risked and shied away from equities in favour of bonds, which were deemed to be safer. Accounting changes requiring companies to disclose the deficits of their DB schemes also played their part. The bulk of this shift away from equities occurred 2000-2015.
One of the notable features of the foreign pension funds investing in our equities is that they are significantly larger than British pension funds, which tend to smaller and fragmented – there are over 28,000 DC schemes. When British pension funds have come together, such as the Local Government Pension Schemes (LBPS), the results have been positive. The LGPS has assets of £342 billion, around 75% of which is invested in equities and other risk assets.
Through the Edinburgh Reforms the Government is taking several steps in the right direction, there is scope for further measures to incentivise the consolidation of pension funds and to encourage greater enthusiasm for British equities. Personal Equity Plans, launched at the height of Thatcherism, used to require a minimum threshold invested in these assets, and this approach should be extended.
The Government should introduce tax incentives to encourage up to a third of our pension fund assets be invested in LSE quoted companies. Some pension fund managers may gripe but their funds benefit from various Government-led policies and tax concessions, including auto-enrolment which obliges everyone to pay into a personal pension scheme. It is fair to ask in return that 33% be invested whence it came.
Some managers may also complain that the British market is bereft of opportunities. The facts do not substantiate this. The British market has always provided bountiful opportunities for those who knew where to look. We tend to be bright lot in this country – enterprise and innovation runs through our veins.
Many fund managers, particularly those managing British-focused investment trusts, have good long-term track records. For example, last autumn, Bloomberg data showed the 20-year sterling total returns on £1 invested for Finsbury Growth & Income Trust (FGT) to be £8.07 – this compares to £6.36 for the S&P 500 and £3.32 for the FTSE All-Share indices.
And given the low rating of the British market relative to others despite good prospects, and the fact the changing market regime favours value stocks at the expense of more highly-rated growth stocks (which helps to explain why the UK market has been outperforming its peers of late), this is a good juncture to for the Government to act.
Given the significant size of the assets under management, encouraging British pension funds to invest greater amounts in LSE companies would make a huge difference and benefit the stock market and City, the companies being invested in and their investors given many comparable British companies stand at a discount to their international peers. The effect could also become self-fulfilling in that rising valuations would itself attract global investors.
There are a number of ways to encourage more domestic investment, with a mix of carrots and sticks. Tony Blair and William Hague recently suggested one variation – that the pension capital gains tax exemption should only remain for funds with over £25 billion under management and which allocated a minimum percentage (say 25%) in British assets.
The Chancellor needs to be bolder. Given the global preference for large incentives to encourage domestic investment, whether it be the American Inflation Reduction Act or the EU’s equivalent, Britain cannot be complacent. Ensuring that our pension funds increasingly invest in British firms will help keep them, their value and their IP in the UK. It is a win-win scenario which the Government should seize before someone else eats our lunch.
John Baron is the former Conservative MP for Basildon and Billericay and a former Shadow Health Minister.
