We can’t afford to allow our pension funds to shun UK assets any longer
By Simon French, Chief Economist and Head of Research
The last month has seen more companies signalling their departure from the UK stock market. Ashtead, Loungers and Renewi have added to a de-equitisation trend that began decades ago but is accelerating. Poorly designed UK regulation that incentivised a shift away from shares and towards bonds has been amplified by procyclical investment consultants - often failed investment managers - and the impact of Brexit. The tax system has also been perverse. UK taxation actively disincentivises retail investors from owning UK stocks by levying Stamp Duty on UK purchases - something unlevied on foreign-listed shares – whilst the removal of the Dividend Tax Credit in 1997 has played a big role in the UK pensions system now owning just 3% of its assets in UK-listed shares. This figure was almost 50% in the early 1990s.
The result of this mismanagement under successive governments has been a cratering in liquidity, sustained underperformance of the UK stock market, and a hollowing out of the UK tax base. UK companies that previously sought capital from UK savers, are now tapping debt markets, or international exchanges. For those companies without those options the hurdle rate to conducting investment and research and is now twice as high as for equivalent US-listed companies. This puts the UK economy at a clear disadvantage to its international peers.
Last week Bloomberg produced analysis suggested the UK has recently fallen to 20th place globally for new companies coming to the market in the form of Initial Public Offerings (IPOs). The interim report of the Pensions Review released last month identified the UK pensions system as an international outlier on how it has turned its back on its own market. UK pension funds now allocate just 10% of their stock market ownership to their home market. In Australia, Canada and New Zealand - this allocation is 36%. Speaking to Australian asset managers in recent months it is clear the importance of Franked Dividends in Australia - the equivalent to the UK’s long-abolished Dividend Tax Credit. This has supported exposure levels to the Australian market and provided a healthy stream of capital for Australian growth companies.
What may feel like a sympathy-light crisis for banks, brokers and advisers is rapidly morphing into a problem for the UK taxpayer. As the public company tax base diminishes, and the UK exit route for private equity is either blocked or takes the form of international bourses, the addressable corporate tax base is shrinking. PWC’s analysis of the 100 Group - the 100 largest UK public companies - show that in 2023/24 they contributed 10% of all UK tax revenue through direct or indirect taxation. If these companies increasingly choose a more tax-efficient debt-fuelled path, or their corporate centre shifts to another country, then the impact for the UK public finances would be catastrophic.
The government, like its predecessor, has diagnosed the problem and made some notable reforms to make it more attractive to raise UK public equity. These “supply side reforms” have been creditable. However, they have done little to reverse flows of capital out of the UK market, raise depressed valuations, and reduce the incentive to delist. The UK Pensions Review is, as one of its four workstreams, reviewing the investment allocation of the pensions industry. Its latest report did not rule out mandating UK pension funds to own more UK assets. Such a policy would be a controversial and my fellow Times columnists, Patrick Hosking and Oliver Kamm, have both recently criticised this suggestion. The Governor of the Bank of England, Andrew Bailey, has also opined that this is not the answer. However, to have a credible voice in this debate you need to suggest an alternative to the current state of managed decline. Too many go strangely quiet at that point. That infers belief that this huge market failure naturally corrects. It wont.
The pipeline of highly profitable commercial ideas coming out of the UK - contrary to consensus - has shown little evidence of slowing. What has become a barrier is that companies raising money in the UK must give away a larger part of their ownership compared to equivalent companies in mainland Europe, the United States, or in private markets. This is a really important point as a hollowed-out UK stock market with only 2% of its companies in the high-growing technology sector is not going to regenerate naturally. Why would entrepreneurs give away more of their company than is necessary? And even in sectors where the existing public company returns have been impacted by competition, regulation, energy costs or technological disruption - their valuations are an impediment to raising capital and funding new channels for growth. This is the doom loop the UK market now finds itself in.
So this bring us to what else is available to the government if it is not going to demand that the more than £55billion per year of pension and savings tax relief has some responsibility to support the domestic economy to the same degree as the UK’s international peers. The Treasury have already informed the Pensions Review that the abolition of Stamp Duty and reintroduction of Dividend Tax Relief are out of scope - amidst tight public finances - so the shifting of financial incentives looks like a cul-de-sac.
Disclosure of UK asset ownership by pension funds is a commitment that the previous government has pursued, and this government appears keen on. But this is not moving the dial. The UK’s largest growing pension fund, the National Employment Savings Trust (NEST), last week released a report celebrating the fact that 20% of its assets were held in the UK. Drill down however and it appears less than 2% of assets are in UK-listed shares. The pivot towards private asset ownership makes up the rest. A similar pattern of behaviour has been seen amongst the Mansion House Compact members who the government hoped would allocate towards the UK’s growth stock market – the Alternative Investment Market (AIM) – but the limited movement in allocation so far has been towards private equity. ISA reform and the launch of a British ISA briefly raised hopes, but this was quietly killed off by the government earlier in the year. There is an ambition that fund consolidation amongst Local Government and Defined Contribution schemes will increase UK share ownership. My own research suggests that consolidation will in fact do the opposite and accelerate the shift towards owning UK shares at global benchmark levels - just 3%.
President Trump is going to amplify the issue by putting America first - a stock market that is already an eye-watering 60% of the global index. It is high time the UK government worked out how to put the UK first.
