CONTRIBUTORS
Jessie, Wilson, CFA, FIA
Client Portfolio Manager
UK Equities
Martin Currie
And we will turn our attention to the pensions system, to drive investment in homegrown businesses and deliver greater returns to pension savers* .”
Labour was primed to hit the ground running upon gaining power. Just five days after the election, they kicked off the process of aligning the UK Infrastructure Bank and the British Business Bank under a new National Wealth Fund1 . Just over a week later, the King’s speech confirmed a new Pensions Bill2, which was swiftly followed by the announcement of a landmark pensions review, part of the government’s mission to “boost growth and make every part of Britain better off3”. Rachel Reeves is not wasting any time.
The Autumn Budget, scheduled for 30th October, should provide more details of what the government are looking to implement. However, details are slowly emerging as they test the water with their ideas. They’re interested in directing investment to UK assets, further pooling for Local Government Pension Scheme (LGPS) and Defined Contribution reforms too; areas that are already splitting views of the pensions industry. There’s one thing we all can agree on, fascinating times are ahead, the new government’s “big bang” approach to pensions is coming.
Productivity puzzle: pension plan panacea?
Economic growth was a central theme in Labour’s election campaign. The UK economy’s growth has lagged the Organisation for Economic Co-operation and Development (OECD) economies for over a decade and if it had grown at the average rate of OECD economies since 2010, it would be £143.3 billion larger4 .
One of the main challenges that’s faced the UK economy has been its low productivity growth. The UK government has recognised the importance of boosting productivity to achieve long-term economic growth. An array of growth focused policies will be employed to address this. When launching the pensions review, it was noted:
- An investment shift in defined contribution schemes could deliver £8 billion of new productive investment into the UK economy5
- Action will be taken to unleash the full investment might of the £360 billion LGPS to make it an engine for UK growth5
It’s not surprising that the government have had their eyes set on UK pension pots as a way of providing investment to stimulate growth. The total amount of UK pension investments is estimated to be approximately £3 trillion by 2030, with around 15% of this in LGPS schemes6.
It’s unclear if the government is solely focusing on private investment, particularly via the new National Wealth Fund, or if listed equity investments are in scope too. UK equity investments by UK pension schemes have fallen significantly over the past 40 years, more than halving in the period 2006-2020. Whatever they’re planning, the government is more than aware that the current low allocations to the UK gives a lot of headroom for an uptick in schemes’ domestically focused investments.
Source: Pensions and Lifetime Savings Association. Pensions & Growth: Creating a pipeline of investable UK opportunities as at August 2024. DB Private' and `DB Public (funded)' refers to defined benefit occupational pensions schemes, respectively for private corporations and public sector bodies. `DC' is defined contribution occupational pension schemes.
However, they're bound to face some serious resistance if they try to dictate investment choices. Trustees and committees are more than aware of their fiduciary duties, but their decision making is driven by more than a legal requirement. Most hold these positions as they want to make decisions they believe are in the best interests of those they represent. Any obligations that could infringe this, will not be implemented lightly.
UK equity investing offers great value
Yet, if we move away from the debate around how government intervention may evolve, on a standalone return focused basis, there is an extremely strong case for increased allocations towards UK equities.
Source: Bloomberg as at 30 June 2024. Price/Earnings ratio (P/E) is the share price of a stock, divided by its per-share earnings over the past year. For a portfolio, the weighted average P/E ratio of the stocks in the portfolio. P/E is a good indicator of market expectations about a company's prospects; the higher the P/E, the greater the expectations for a company's future growth in earnings.
Labour have talked a lot about the need to revitalise UK growth. They’ve talked less about how the UK economy was already on an upwards trajectory when they took power. Inflation has come back into target, GDP growth numbers are beating expectations, consumer debt and corporate borrowing are at reasonable levels, and rate cuts have begun. We may still be at the beginning of a recovery, but UK confidence is certainly on the up.
Despite a rapidly improving economic backdrop, UK equity valuations are below their historical averages and lower than most of their international peers. I don’t know about you, but I find the potential of a UK valuation rerating, coupled with strong economic growth, a tantalising investment prospect!
Yet, many pension scheme asset allocations are in line with the standard textbook recommendation of moving towards global allocations. The MSCI World Index, which covers large and mid-cap securities across 23 developed market countries, as of July had only 3.8% in UK equities7 – this is such a small proportion as it’s backwards looking based on market capitalisation, not forward-looking based on future return opportunities. Active funds are not much better, typically having 6% in UK equities8. Whether active or passive, global investing limits your exposure to the UK market, which means limiting your exposure to an asset class which we believe has exceptional return potential.
Beyond bargains: the UK’s long term investment potential
Investing in UK equities isn’t just a valuation story. It’s easy for us to note that valuations are cheap and overlook all the strong positive drivers that make the UK investable for the long term.
Structurally, the UK benefits from world leading universities, a solid legal backdrop, and an ability to draw talent and investment internationally. These elements support the UK in sustaining its leadership status across several industries and markets. We have a competitive edge in areas such as digital innovation, financial services, green technology, and creative industries, which can drive future growth and productivity. This gets even more interesting when coupled with the new government’s ambitious growth plans to invest in infrastructure, skills, research and development, and regional development.
Additionally, measures are being implemented to support the UK market for the long term. At the beginning of July, the Financial Conduct Authority (FCA) announced a simplified UK listings regime that has already come into force. This is the biggest change to their listing regime in three decades, with reforms aimed at modernising the rules for bringing companies to the stock market and floating their shares and making them more flexible and competitive while maintaining high standards of governance and disclosure. The FCA hope the revised listing rules will encourage increased UK listings, which is important to support a vibrant UK small-cap market, with long-term positive implications across the market-cap spectrum.
Our approach to investing is to consider both macro drivers and the individual companies in which we invest. If you’re interested in some of the up-and-coming UK smaller companies that offer great potential, we’d draw attention to our Transformative Trends series on UK small caps.
- Content creation & intellectual property
- Decarbonisation and three net-zero heroes
- Three small-cap disrupters transforming the digital economy
- Transformative trends: Consumer Brands
Take a second look…
The next parliamentary term will be significant for the future of the UK pensions industry. Some policies will be controversial, any requirement to direct investment will certainly raise significant questions. However, looking through potential regulations and legislative change, it’s certainly worth revisiting your UK allocation. There’s a lot to be excited about with UK equity investing, perhaps you should take a second look.
Footnotes:
*Source: GOV.UK as at 8 July 2024. https://www.gov.uk/government/speeches/chancellor-rachel-reeves-is-taking-immediate-action-to-fix-the-foundations-of-our-economy
- Source: GOV.UK as at 9 July 2024.
- Source: GOV.UK as at 17 July 2024.
- Source: GOV.UK as at 20 July 2024.
- Source: GOV.UK as at 8 July 2024.
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Source: GOV.UK as at 20 July 2024.
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Source: Pensions and Lifetime Savings Association as at June 2023. Pensions and growth a paper by the PLSA on supporting pension investment in UK growth
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Source: MSCI as at 31 July 2024.
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Source: Morningstar as at 30 June 2024. Median UK equity exposure shown for investment vehicles in the IA Global sector.
WHAT ARE THE RISKS?
All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Past performance is not a guide to future returns.
Equity securities are subject to price fluctuation and possible loss of principal.
Active management does not ensure gains or protect against market declines.
Investors should consult their financial advisor before deciding to invest.
