By Hugo Gravell, FIA, Principal and Investment Consultant at Barnett Waddingham
The Government is clearly signalling a push towards bolstering investment at home. But why is this shift so crucial, what should the incoming Government (whichever party) focus on, and what does it mean for both individual and institutional investors?
UK equity allocations have declined in recent decades due to the UK’s underperformance compared to other regions and active decisions by investors to reduce ‘home bias’.
Both individual and institutional investors are reviewing their allocations to UK equities after the Chancellor set out measures incentivising higher allocations in the Spring Budget 2024 including:
An additional ISA allowance for individuals dedicated to investing in domestic shares.
Mandating DC pension schemes to publicly disclose their UK investments.
Consulting on PISCES, an “intermittent trading venue” to help investors trade shares in private companies.
This is a cross-party objective, with the Labour Party publicly committing to the British ISA and proposing its own measures such as a British 'Tibi' scheme to encourage DC schemes to invest in small-cap UK equities.
What is the current Government's position?
Companies are not forced to list in countries where they generate their revenue or base their production. Increasingly companies aim for those markets in which they can maximise their share price. This usually means the US, which has benefitted from strong performance in recent years, significant inflows from global investors, and a huge pool of domestic investors who do not invest outside the US.
For example, Arm, a UK-based semiconductor design company, recently chose to list on the NASDAQ exchange in New York, achieving a valuation that would have made it one of the five largest stocks in the FTSE 100.
For investors with exposure to global equities, the country of listing may not make much difference in the short-term. Returns are returns – and diversification of where revenues are generated matters more than listing locations.
However, for the Government this poses a significant problem. If growing companies choose to list overseas this will make listing in the UK even less attractive for investors, lowering valuations further and beginning a negative feedback loop. In the first instance, lower valuations reduce the amount of capital UK listed companies can raise to invest in their operations. Indirectly, UK financial services account for around 8% of GDP and more than one million jobs – with many tied to services that may move overseas alongside the listed companies. Moreover, the UK Government would lose a significant tool of regulatory control as companies follow US regulations for listed companies.
By encouraging investment in domestic shares, the UK Government is therefore aiming to protect the UK's position as a leading financial centre, support domestic access to finance, maintain its regulatory influence and encourage economic growth. The challenge of competing with the US is not specific to the UK. UK financial markets and services have arguably held up well compared to other non-US markets. This is true across public markets but also early-stage venture capital. Efforts to reduce the frictions involved in investing in the UK are positive. For example, implementing Lord Hill’s Listing Review Reforms, including the PISCES proposal. Even better would be to reduce the cost of investment by removing stamp duty on UK shares.
However, those steps will not be enough to solve the UK's poor track record on investment compared to international peers and stimulate higher levels of growth. We believe the next Government's focus should be on boosting business confidence when setting long-term plans. Consistent policy is more important than good policy. For instance, clarity over long-term plans for UK infrastructure and the transition to Net Zero are essential and would encourage more investment in the UK by both UK-listed and overseas-listed companies.
What does this mean for investors?
We support investors in public equity using a market capitalisation approach as a starting point. This would mean allocating around 5% to UK before considering controlled moves away from this to manage, say, climate risk.
Encouraging investors to increase their exposure to UK equities could lead them to divert funds from regions that have historically outperformed in terms of company fundamentals and valuations. With the UK market skewed towards more mature industries – such as energy, financials, and consumer staples sectors – keeping pace with the tech-driven growth seen in the US will remain challenging. We don’t believe the Chancellor’s recent announcements are enough to move the dial here.
Therefore, we don’t expect significant increases in pension schemes’ UK public equity allocations. DC workplace providers in particular are between a rock and a hard place – the budget simultaneously encourages investment in an underperforming region and sets out measures to stop providers taking on new business if they underperform.
However, we believe the opportunity to invest in UK private markets is more nuanced. While we continue to champion global portfolios, the next Government can help to build opportunities in this space by expanding on recent initiatives – from the Mansion House Compact through to the PISCES and LIFTS initiatives.
This article features contributions from Callum Smith, Senior Research Analyst, and Jack Solomons, Senior Investment Analyst.
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