More meddling in pension investing? At least this time, there’s room to make a profit.
As a financial analyst, I do my best to keep economics and politics at arm’s length. However, when both of the main parties are being equally economically incompetent, it feels like fair game.
The Conservatives have imposed a 75% windfall tax on North Sea energy, leading most producers to plan for an exit, or at the very least reallocate resources. The party has presided over a period where £895 billion of Quantitative easing was created and have kept interest rates below 1% for over a decade.
For those of you who think monetary policy is determined by the Bank of England — wake up.
UK PLC is running like an AIM share in a death spiral. Debt to GDP is above 100% for the first time since 1961, and the tax burden is at its highest since the post-war period. Carefully massaged CPI inflation is running at 8.7%, the base rate is at 5% and rising, and the government is out of money.
For balance, Labour’s solutions read like a child’s wish list rather than any useful proposals. It’s going to end all new investment in the North Sea, but also borrow £28 billion within the first two years in power to fund green energy development — presumably at rates well above 5%.
Hilariously, Centrica has just announced an $8 billion deal with US-based Delfin to buy more LNG from 2027 — apparently, it’s greener to ship the stuff from halfway across the world than develop our own.
The red party is also planning to add VAT to private school fees and axe non-domiciled status just to annoy the top 1% of taxpayers that are responsible for 30% of all revenues. And today — after flip-flopping on rent controls — shadow minister Lisa Nandy has announced she will force banks to offer interest only mortgages and extend terms to borrowers. How could this possibly go wrong?
Pensions funds strategy
But the new wheeze is a blue-side policy: Chancellor Jeremy Hunt, fresh from once again fiddling with windfall tax deckchairs, a useless mortgage charter, and ruling out funded public sector pay rises, has decided that he must once again meddle with pensions.
I’ve already talked about how it’s becoming almost impossible to correctly plan for retirement in the UK, and these changes will just further pile onto this thesis.
The latest conception is that two thirds of the UK’s largest defined contribution (DC) benefit pension scheme providers — including Aviva, Scottish Widows, L&G, Aegon, Phoenix, Nest, Smart Pension, M&G and Mercer — will all ‘voluntarily’ commit 5% of their default funds to unlisted equities by 2030.
This ‘Mansion House Compact’ could represent between £50 billion and £75 billion in additional investment into high risk growth companies if the remainder of the market signs up. At present, DC schemes invest far less than 1% in unlisted companies.
There’s a reason for this — unlisted companies include those on AIM and the AQSE — and these are typically, high-risk, high-reward. Pensions are usually about 60% invested in bonds, because while the returns are lower, they are guaranteed.
You’ll note that defined benefit schemes for public sector workers — including civil servants, teachers, police officers, MPs et al — are not included in this new plan. Hunt expects that forcing pension funds to take on more risk will generate an additional £1,000pa for your pension, but I suspect he has only read the high reward information and neglected to consider the high risks.
I’ve talked about this at length before — 90% of biotech startups fail, and he wants the funds to specifically start with targeting the life sciences sector.
On the plus side, Hunt is planning to get rid of the MiFID II rules, which prevent stockbrokers from providing research for free by bundling it with share trading services that clients pay a commission for. This will help, even if some unscrupulous actors will take advantage.
The Chancellor argues that the £2.5 trillion pensions market currently suffers from a ‘perverse situation’ whereby funds prefer to invest in international growth companies rather than those listed in London. He is clearly desperate to increase long-term UK growth, but without committing to better tax incentives, or more state borrowing, or actually making the UK more appealing — and in my view, high risk investing using pension funds will only end in tears.
However, not before AIM investors realise some serious profit. It’s worth noting that while AIM shares are colloquially referred to as ‘listed on AIM,’ they are in fact not listed, but rather ‘admitted to trading.’ This is an important distinction in the context of the pension changes.
Why? The AIM market’s total net market cap — or the value of all 718 AIM shares combined — stands at a little over £56 billion. If this additional £50-75 billion gets invested in small caps, then the market value of the index could double by 2030 and solve the funding issues that are plaguing the UK’s best growth companies in an era of rising rates and tightening monetary policy.
Sentiment is currently poor on the index — shares are falling fast as investors pull funding in favour of risk-free gilts, American blue chips, and amid fears of near-term financial problems. Long-term investors in quality companies could well profit in the years to come.
Of course, the devil is in the details. At present, the commitment is only ‘a desire’ to invest in the next generation of UK scale-ups ‘as part of a diversified portfolio,’ with no geographical restrictions. There’s a good chance that this is all bluster to quieten a Chancellor a year or so from mandatory retirement.
Separately, the government no longer requires short-selling funds to publicly disclose their trades on UK companies. They will still have to report their positions to the FCA, but the threshold for reporting is also increasing — currently a fund must tell the FCA when they have borrowed 0.1% of a company’s outstanding stock in order to s — that threshold is doubling to 0.2%.
This has positives and negatives but is worth mentioning to investors keeping track of UK investing changes.
As ever, the UK continues to mess about with long-term investing. Rules change and can be changed back with little notice. But while this increased cash aimed directly at the small cap sector will likely be a disaster for pension funds due to the high failure rate, AIM investors like me are quietly appraising the most likely targets for funding.
More on these next week.
This article has been prepared for information purposes only by Charles Archer. It does not constitute advice, and no party accepts any liability for either accuracy or for investing decisions made using the information provided.
Further, it is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.