“The primary function of a nation’s capital markets is to channel the country’s savings into productive investment, which in turn underpins long-term growth and productivity through superior capital allocation” (Tony Blair Institute for Global Change).

The case for Pension funds and ISA’s to own UK listed equities.

But first a history lesson:

Personal Equity Plans (PEP’s); anyone remember them? They were introduced by Chancellor Nigel Lawson in his 1986 budget to encourage equity ownership. They were available to the investing public from 1 January 1987 and similar to today’s Individual Savings Account (ISA) they were tax exempt savings vehicles free from capital gains and income tax. They were very popular, in the first month of the scheme’s availability 2000 people a day took out a PEP (source: Hansard). 

The interesting bit (for me) was that 50% of the PEP had to invest in qualifying investments i.e. the UK (later 50% European equities.. the beginning of the end) and as an extra incentive to invest if you held cash, the interest payable wasn’t tax free. This qualifying rule was removed in 2001.

Pensions; In 1997 Gorden Brown (Chancellor in Tony Blair’s Government) abolished the dividend tax credit to encourage UK companies to invest rather than pay out dividends. This may have been a good idea but an unintended consequence of this move was to make UK equities less attractive for pension funds. A further change in legislation in 2003 led to new requirements for UK companies to include pension-fund assets and liabilities on their balance sheets. This led to the majority of defined benefit pension funds closing and the Trustees understandably taking a much more cautious approach in their investment strategies. From the introduction of these two measures UK pension fund (UK) equity holdings have fallen from circa 50% of the average pension fund portfolio to circa 2.7% today.  

There are many commentators that say we should not dictate where companies, Trustees or individuals should invest their money. I agree. However in the UK we grant in excess of £50 billion each year in pension tax relief. As with ISA, pension fund investments are exempt from both income and capital gains tax. Why should the Government not require some of this money to be invested in the UK? Instead we are reliant on foreign investors (holding 57.7% of UK equities)* to underpin our capital markets.

Some commentators suggest that it is the size or relevance of the UK market that has led UK asset allocators to look abroad for their returns. I disagree. If that were the case companies listed in the UK would not be undervalued relative to their peers. It also doesn’t explain why Australia, Italy and France have significant domestic exposure to their home markets (37.7%, 41% and 26% respectively).

So what is to be done?

There are a number of initiatives introduced by former Chancellor Jeremy Hunt to encourage participation in the UK equity market. One proposal is the introduction of a UK ISA with an additional (to the current £20,000 allowance) contribution level of £5,000. This in itself will not move the dial much but it is symbolic and shows that the (former) Government was starting to take the matter seriously. There are also a number of other initiatives such as defined contribution schemes disclosing their UK asset allocations by 2027 and the Mansion House Compact in which 9 of the leading defined contribution pension providers committed to increase their UK  exposure to 5% of scheme assets by 2030. 

Conclusion

The proposals referred to above are a good start but my preference would be something more radical. I’m an advocate of compulsion. If you benefit from a tax advantaged UK investment vehicle then you should have to have a decent allocation of your investments in UK companies. It doesn’t stop you investing elsewhere around the globe, you just won’t get the UK tax breaks to do it.

The Tony Blair Institute For Global Change produced a paper (May 2023) “Boosting Savings and Prosperity for the UK”. They are essentially advocating rolling out UK pension superfunds. It might not be the answer but it shows that the matter is being given some serious thought. We don’t yet know who will form the next new Government in the UK. But if it is Labour under Keir Starmer then who knows? Apparently Sir Keir is taking advice from Sir Tony in the run up to the election! Ironic really when it was PM Blair’s Government that set us on this path some 20+ years ago. Link to the paper.

* Source: ONS December 2023