I have spent the early hours of a Saturday morning reading and absorbing the excellent report from the Capital Markets Investment Task Force “Capital Markets of Tomorrow“. It’s prep for my writing a response to the Treasury’s call for evidence on Pension investment.
This report is signed off by Nigel Wilson, formerly of L&G and someone who shaped my thinking on the importance of productive capital both to savers and to the economy You can read “Basis for Beveridge” that inspired me back in 2015 at the end of this blog.
The report kicks off with a reprise of the Mansion House Compact, to which Wilson was a signatory
The goal was for growth to be delivered by Defined Contribution pension funds investing 5% of their assets in unlisted equity by 2030. As fast-growing pool of investable funds – it will be £1 trillion by 2030 – this has potential to be game-changing, and encouragingly, a recent ABI report highlighted that progress has been made by ten of the eleven signatories.
We are indeed seeing signs of change with sleeves of UK-centric private market investments emerging in some master trusts and with the creation of long term asset funds. But progress is slow and clearly there is a need for acceleration, hence the Treasury call for evidence.
Opposition to change has come from the trustee lobby which argues that creating a home bias for investment would lead to underperformance
2010-23, the USA has delivered 8.4% and the UK only 2.2%, a significant and possibly “embedded” outperformance.
The CMITF report sets out to answer a key question;
A key question is whether this is an aberration, and the UK will deliver “mean reversion” in equity returns and growth metrics over the next decade, or whether the gap is here to stay. We are
optimistic, and believe that the UK can return to its pre-existing parity
Not it seems if we continue to prioritise debt over private capital, an unexpected consequence of the demand created by DB pension scheme de-risking has been that pension schemes have inadvertently become both agents and victims of QE.
The UK, with £2.7 trillion of Government debt, budget deficits and the BOE selling gilts, means a huge supply of gilts, possibly £1.25 trillion in the next five years. The UK needs to avoid crowding out private capital and interest rates being
too high, therefore discouraging investment. This represents a significant challenge for the Debt Management Office.
A reversal of the trend is now needed, for growth to resume at an acceptable level to reduce the public debt.
Mathematically we need to invest around an additional £100 billion of productive capital per annum for ten years, so £1 trillion in total, to deliver 3% annual growth in real wages and real GDP per capita.
Both in absolute and relative terms, we have under invested and over-borrowed.
We know that since the GFC (global financial crisis) the UK has underinvested both in absolute terms and compared to our G7 peers with our Investment/GDP ratio around 17 to 18% compared to our peers of 20 to 25%.
The Report presents us with a mixture of fiscal and behavioral measures to make this turnaround happen
- Creating incentives for institutional investment in UK companies: by ensuring that more of the £60 – £70 billion per year of taxpayer money that is used on annual pension tax benefits is applied in a way that encourages investing in UK companies.
- Removing barriers to institutional investment in UK companies: Reversing the dividend tax impact on pensions funds introduced in 1997 by re-introducing tax credits on dividends received from UK companies.
- Creating incentives for retail investment in UK companies: introduce a streamlined ISA product that builds on the idea of an increased tax-free allowance for investments including in UK companies (i.e. the “UK ISA”).
- Removing barriers to retail investment in UK companies: this includes exploring ways to lower or remove Stamp Duty Reserve Tax (SDRT) on shares. The UK currently
taxes its retail investors with SDRT when buying a UK-listed Aston Martin share but not when buying a German-listed Porsche share or US-listed Tesla share.- Encouraging individuals in the UK with the capacity to invest in risk assets to do so: the UK could allow institutions to nudge those holding high amounts of cash savings towards investments. Greater financial education and better advice can also play a key role here, and the Government should work with industry on a national public campaign on why investing in UK markets and supporting UK companies matters
Allied to this is the need to create the conditions for demand for all this money (capital)
On the supply side, the UK needs to ensure it is creating the environment for high margin, high growth companies to flourish and remain in the UK:
Wilson and his team call for a return to a “risk-on” culture where the risks taken are understood and properly managed.
A move in this direction has been seen in recent reforms, including changes to fee caps in DC pensions and the focus on more outcome-based investment for LGPS funds – all of which are designed to encourage considered risk-taking.
However, this change must happen not only at the level of regulatory policy, but also at the level of implementation and supervision of firms. The competitiveness objective for regulators is a key component of this and it now must be reflected in the day-to-day activities of regulators.
