Some like to claim that the poor performance of UK equities is due to these pension schemes (and retail investors) selling UK shares and buying global equities. However, the Global index trades on a higher price-to-earnings multiple than the UK Equity index, but that difference has not changed significantly over the period as far as I can recall.
For the ratios be unchanged, the performance difference between the two indices must be based on a slower rise in underlying cash flows in the UK than in the stocks that make up the Global index.
Indeed, given the index high weighting to slow-growing banks, oil and mining shares and the high weighting in the global index to technology, that seems to explain the relative performance – as well as the perceived ‘cheapness’ of the UK equities compared with global equities.
However, there is a second factor that has led DB pension funds to sell down their UK equity holdings. This was a change in the tax treatment of dividends in the early 2000s.
In 1999 Gordon Brown removed the ability of pension funds to reclaim 10 per cent of the tax paid on dividends they received from UK companies – so-called advanced corporation tax.
This seemed a modest measure, but when compounded over the years that pension funds receive dividends, it all adds up. If we retire at 65 and live until we are 80, DB schemes must pay our pensions for 15 years.
Longer dated gilts can cover these liabilities, but are very volatile, especially if there is an unexpected period of inflation within that period – our pension payments generally adjust to inflation, whereas gilt yields do not.
It therefore makes sense for pension schemes to use the dividends from reliable companies like Unilever or Diageo to cover these longer lasting liabilities as these dividends do tend to keep up with inflation.
It is notable that in Australia, a pension system quite like ours (but better funded), domestic pension funds continue to receive higher dividends than overseas investors (so-called franked income rules). This is likely to be a major factor in Australian funds’ as domestic equity weighting is five times larger than that in the UK.
Maybe the chancellor will reverse this tax item to increase the UK allocation, it would cost a small amount of tax income, but might result in a large amount of capital returning to UK equities.
Similarly, the UK is unusual in charging 0.5 per cent stamp duty every time you buy a share. Cancelling stamp duty would please all investors globally and so might increase investment enough to offset the reduction in income from the stamp duty.
