The government hopes that by providing additional tax breaks, the UK ISA will increase the capital available to domestic businesses. But Paras Anand says the main reason for Britons to invest more in the FTSE is their own prosperity.
In the ‘90s, everyone in this country seemed to have most of their investments in UK shares. Articles would appear in the Sunday papers exhorting us all to think more globally. And we listened.
The trend towards passive investing made it much simpler for investors to buy international shares. Trackers that mirror indices such as the MSCI World have just 4% exposure to the UK market. More than 70% of the index is in US stocks.
Back in the ‘90s, defined benefit pensions funds and insurance companies owned around half the UK equity market. Today it is just 3%1.
The surprise recently was perhaps not so much that one of the UK’s best-known wealth managers was reducing UK equity exposure from more than 20% to less than 3%, as how long it took it to make that decision. Has it got its timing wrong?
In recent years, investing in the US over the UK has been a smart move. But there is a growing argument that this is changing. The FTSE 100 hit 12 record highs last month2. I believe that trend can continue. My big concern is that UK investors will miss out. We’ll come to that point later. First, I should make the case for why I am so bullish on UK equities.
There are three main reasons I believe UK equities can continue to rise in value:
1. The pension shift
First, even without a change in asset allocation, UK pension funds will be buying more UK shares. Research from Goldman Sachs shows that old-fashioned final salary pensions schemes – defined benefit (DB) schemes as they are known – currently hold seven times the assets of modern defined contribution (DC) schemes. But they are shrinking, whereas DC schemes are taking in more than £20bn a year in fresh employee and employer contributions. By 2032, DC schemes will be bigger3.
DC schemes have nearly half their money in equities compared with just 15% for DB schemes – so three times as many UK shares, proportionally. It means pension schemes are now net buyers of UK shares.
I don’t want to exaggerate the impact of this shift in the pensions landscape, but it helps. If pension funds were to reconsider their allocation to the UK, that would make a bigger difference. They would certainly struggle to allocate less than they do today. In Australia and Italy, pension funds invest about 40% of assets in their own domestic markets4.
A change in sentiment in UK markets, and possibly some carrot-and-stick encouragement from government, could lead to a meaningful change in flows. That debate is now happening in Westminster and the City.
2. Valuations
The UK is still cheap5 – relative to its own history and to the rest of the world. This is a well-rehearsed argument. Only technology stocks are more expensive than their 10-year average. Some sectors – consumer staples, utilities, financials and telecoms – look extremely cheap versus history.
