Are bonds “productive finance”?

A little group of us are having a  vigorous debate about the definition of productive finance and what falls within its scope. I have taken as my starting point, the definition  from Barry Kenneth – CIO  at  the PPF  

“Until the Chancellor’s Mansion House speech in July, not many outside the financial world had heard the phrase ‘productive finance’. And even within the financial world, it’s fair to say that there isn’t an absolutely fixed definition of what productive finance assets are, and you’ll get a different answer depending on whom you talk to.
But to my mind, and from the PPF’s perspective, productive finance assets are Equity (both Public and Private), and Real Assets (which includes Real Estate, Infrastructure, and Timberland and Farmland). They are investments which help support businesses and the wider economy.
We also invest heavily in the Debt of Infrastructure, Debt of Real Estate and Debt of general UK Corporate Businesses. However, in the cleanest classification of productive finance, we exclude these transactions from our numbers.

In our discussion so far, I am the one in four who reckons that buying bonds is not an investment in productive finance. I have always believed in long term investment in  real assets and that the market that finances them is secondary.

As I understand it, the purpose of Government issuing gilts is to finance the big things that it doesn’t want to pay for from general taxation. Gilts are their way of financing everything from the Covid recovery schemes to the 40 new hospitals we’re getting  (sort of).

Pension funds are the biggest buyers of long-term and inflation linked gilts and so are already helping to finance the UK. Our contributions and those made by our employers (as deferred wages) are financing the country and the country is paying us back through the yield on the gilts. Which suggests that if our definition of Productive Finance is to include “debt” , we are all investing in productive finance (except those who buy annuities who use corporate debt instead). So even if you invest in an annuity, your money will be being used productively.

JOB DONE! Well not quite….

What Mansion House is saying is that it wants pension schemes not just to continue financing real assets, but owning them.

The PPF distinction is very interesting, it includes the ownership of listed securities including quoted shares as investment in “productive finance”.

Illiquid ≠ Productive

The liquidity provided by the market can provide easy recourse to cash and much greater transparency as to what people are prepared to pay for a share of an asset (note the current discounts on many investment trusts relative to open ended funds).

But just because an asset is illiquid (for instance stuck in a gated LTAF) does not mean it is more productive, it just means it’s not sellable at the moment. This is supposed to provide an illiquidity premium (extra return for the lock-up) but that does not mean the asset is being more productive for being illiquid, it just means it can’t be sold.

Likewise, many argue that unlisted debt (private credit) is more lucrative to those who buy it than listed bonds and gilts. This may be the case, not least because of the liquidity premium , but also because private credit is a “new found land” , giving rich returns to the intrepid. This is where I think the confusion about Productive Finance gets its focus.

What I think is happening, is that investors are confusing illiquidity and productivity, finance and ownership and skill versus market returns. Simply buying a market using a passive pooled fund does not require skill, buying a portfolio of private credit does (if done properly). But we are not here to measure skill, we’re here to think about the investment in productive finance.

So, following the logic laid down by the PPF, an investment in a UK FTSE 100 index is a an investment in productive finance while the purchase of a portfolio of private credit – isn’t.

Investing in productive finance is not about skill , it is about conviction, investment beliefs and it’s about getting all the stakeholders onside. Fiduciaries, executive, sponsor and even members must be aligned in wanting to get down deep and dirty in investment in the things we see around us – whether they be Fintechs or hospitals. Taking meaningful stakes in such  great projects usually means greater stewardship in their management and that means committing human resource. Human resource means higher fees and that can only be justified in VFM terms by higher returns.

The big questions about productive finance are not about definitions, they are about the cost of ownership and the value of ownership. These are questions that don’t apply if you hold bonds, which is why I don’t think we should include bonds in our definition of productive finance.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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7 Responses to Are bonds “productive finance”?

  1. conkeating says:

    You cannot distinguish productive finance by its form or structure, debt or equity. Productive finance is determined by the purpose to which it is put. Gilts issued to finance investment are productive finance, those issued to finance general government administrative activities are not. In the private sector, the same applies.
    The PPF is wrong,… again. Certainly not all equity qualifies as productive finance but not all debt issued fails to serve as productive finance.

    • jnamdoc says:

      Con is correct.
      Gilts bought (and issued ) to finance the NHS might be a good and social thing, but it is not an investment in productive assets. The excess concentration in single issuer Gilts, is akin to a Ponzi.
      The question you are touching upon Henry is more about the merits of direct ownership, primarily as a means of reducing the agency risk and graft, which is an issue of chronic proportions in UK pensions. The last 20 years has witnessed the most wonderful growth in the scale and wealth of the consultancies ‘supporting’ DB schemes while overseeing the decimation of private sector DB. That’s a symptom of the Agency issue – good for consultants and intermediaries, at the expense of the pensions of working people.

      • Derek Scott says:

        As well as considering the merits of “direct ownership”, I’d suggest pension funds also look at whether or not their investment managers co-invest, and how much (aka skin in the game).

        And I don’t mean carried interest and similar incentives, I mean personal capital at risk.

        I’m old enough to remember when private managers might have 20% or more of the fund, which is meaningful. Around 1% or less, on the other hand, is not.

        This could also apply to listed investment managers.

  2. conkeating says:

    For the avoidance of doubt, liquid versus illiquid is simple a question of form (or structure) to which the same distinction applies.

  3. henry tapper says:

    Con, for the purpose of discussions today, I am going to leave the subjective discussion on “purpose” out ot it. I think that some investment is more purposeful than others but I’m leading a discussion this afternoon where we will quickly get bogged down if we include a view on purpose and intent!

  4. John Mather says:

    You could ask what is the purpose of the term and is there any merit in adding yet another opaque term to the jargon

  5. Eugen zn says:

    I am not sure why this discussion exists. We are discussing capital allocation here, and cost of capital.

    Businesses have their own logic on how much capital need and in what form: equity or debt. As a general rule a new company needs equity, but as it starts to have a high cashflow may want to change its capital structure and issue corporate bonds and use the proceeds to buyback some of its stock. Is this productive or not, Henry? For example Apple did $100 billion worth of that, this is its long term debt position at the moment.

    If I invest in Apple’s bonds do I care if it is productive or not? I will pay more attention to the spread over US Treasuries and just about it.

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