UK equity markets could do with some shock therapy
My favourite explanation as to why UK pension funds have shrunk their investments in UK equities from around 50 per cent in the 1990s to a paltry 3 per cent today was offered to me recently by one of the City’s veteran fund managers; “You can trace it all back to the day that crook Robert Maxwell fell off his boat.”
Leaving aside the debate about the circumstances of the media mogul’s death in 1991, the suggestion is that the subsequent revelations regarding the true scale of his theft from company pension funds triggered a wave of de-risking strategies, one of which was to begin a shift away from equities in favour of fixed-income assets and a more diversified portfolio.
The maturation of funds, regulatory changes and the opportunities of globalisation meant that by the turn of the century this trend was well underway. There is now some debate as to whether the disinclination of pension funds to invest in UK equities is a symptom or a cause of the malaise that now runs through the UK’s capital markets ecosystem. The truth is that funds have a fiduciary duty to manage risk appropriately and generate returns, and if UK equities simply don’t fit into that framework no amount of browbeating is going to change their minds.
The government seems more interested in encouraging pension funds to invest in unlisted equities, an approach set out in the Mansion House Compact under which many of the UK’s largest pension providers committed to allocating at least 5 per cent of their defined contribution funds to this end. More recently, the Chancellor’s ambitious plan to merge smaller public sector pension schemes into megafunds is aimed at deploying billions into high-growth private businesses and national infrastructure.
So, where does this leave the UK’s equity markets? A lack of liquidity and the associated issue of relatively lower valuations (compared to US stocks) along with a traditionally larger emphasis on dividends (as opposed to growth) all combine to undermine the attractiveness of UK capital markets. On top of this, the pernicious impact of stamp duty on share transactions discourages participation, particularly among retail investors.
The government is fully aware of these issues and City chiefs say they enjoy good access and engagement with the Treasury on the topic, so all eyes are on the publication of the financial services element of the government’s long-awaited industrial strategy. As one investment bank chief put it to me this week, the Big Bang was only visible in hindsight. In other words, a series of incremental changes and smart reforms could yet combine to revive the UK’s public markets.
The issue is whether we look back in five years and see a series of wise decisions, or a missed opportunity.