What if UK pensions schemes looked like their Australian and Canadian cousins?
Emma Mogford, Premier Miton Monthly Income Fund manager, reflects on what it would mean for UK companies if our pension schemes invested more in their domestic market.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Buy British? But why?
Trends fascinate me. Market trends, behavioural trends, consumer trends. Part of my job as a fund manager is to identify and consider these trends – they vary in velocity, duration, magnitude – at times they excite me, at times they concern me.
I often use these insight notes as a platform for writing about the current valuation argument for owning UK equities and the potential for positive future returns – a trend inextricably linked to my day job if you will. However there has been a structural trend in our UK pension funds where since 1997, according to New Financial, the allocation to UK equities has been decimated to fall from 53% to as little as 6%. A trend that falls into the camp of worrying me, rather than being immediately exciting.
Headline asset allocation of UK pensions 1997 to 2021
Source: New Financial data from 1997 to 2021
Capital is the catalyst to growth
This trend sees the long-term investments, the pension schemes, of UK companies choosing to invest outside the UK. But what if that changed, what if we saw a reversal in that trend and we moved to the c22% allocation to its domestic market we see with the Australian superannuation savings scheme?
Firstly, are the benefits to the UK economy. By pension schemes investing, they introduce more money into a market. UK pensions represent a significant amount of capital, where they invest increases market liquidity, lifts market valuations and makes a market function more efficiently. This flow of capital rewards businesses with high returns with high valuations.
Having a vibrant domestic equity market makes it easier and cheaper for businesses to gain access to investment capital and in turn cheaper capital means a greater ability to grow and invest which means more jobs and tax revenue. Investment capital in this regard is the catalyst for economic growth and from the above chart we can see UK pension schemes have been shifting capital away from UK companies.
Company ‘investment’ or ‘capital expenditure’ can sound a little meaningless but it has real tangible benefits. One important area of spend is research and development which leads to new products, and it also improves productivity which means companies can effectively create more with less. Productivity is the key source of economic growth and competitiveness. A country’s ability to improve its standard of living depends almost entirely on its ability to raise its output per worker and productivity growth leads to economic growth. Increased capital availability leads to investment, this can mean adding a new factory or warehouse which increases a company’s ability to grow sales and create new jobs.
A complicated relationship
The link between economic (GDP) growth and investment in the domestic equities is not a straightforward causal relationship. It is likely that the conditions which make for good GDP growth may also create an environment for domestic equities to perform well. The chart below shows the value of the UK stock market as a % of GDP has fallen 10% points since 2002.
Value of companies listed on comparable stock markets relative to GDP
Source: New Financial data from 2002 to 2022. The ‘Group’ data series is represented by Australia, Canada, France, Japan and Switzerland.
Another important area of investment is in infrastructure. Pension funds around the world are important providers for capital into projects to build wind farms and electricity networks, build houses and build faster broadband and mobile networks among many other things. This infrastructure may deliver significant benefits to an economy such as cheaper energy and cheaper housing. And again, productivity benefits can fuel economic growth by removing capacity constraints and reducing the cost of production.
Made in Canada
Canada is home to some of the most admired and successful pension organisations, according to the World Bank. Over the past 3 decades they have emerged as models of how to best run pensions with independent governance, professional in-house investment management, scale, and extensive geographic and asset-class diversification.
The Canadian pension plans allocate a high proportion to domestic Canadian assets. Within the allocation to Canadian assets there is a significant allocation to ‘other assets’ such as infrastructure. It shows a commitment by pension plans to invest in their country and the subsequent economic benefits such as innovation, jobs, stronger economic activity and financial security for pension owners.
Advance Australia fair
The superannuation schemes in Australia are the envy of other countries facing major pension shortfall as these funds set up in the 70s and 80s have made Australia the 4th largest holder of pension assets in the world at $3.5trillion according to Wikipedia as at 30th March 2022.
In Australia today, employers make a mandatory contribution, currently 11% salary minimum, to an employee’s pension which is collectively invested in large funds – either multiemployer funds which are not-for-profit mutual funds run by employer associations or retail funds.
Thanks to ‘franking credits’ there is a big advantage to investing at home in Australian companies, especially those which pay a dividend. The logic goes that the company has paid tax on its profits in Australia, so the dividend has already been taxed. The investor receives a franking credit which can be used to reduce an investor’s tax bill or for those already in retirement it can be paid back to the investor as a cash refund. Thanks to this, there is a significant allocation to Australian companies, which make up 22% of the average Australian super.
An article in The Sydney Morning Herald in 2019 identified Australian Supers as being hugely important buyers of Australian company shares. The article highlighted that Super fund ownership was 37% of the value of the total Australian equity market. Clearly that gives them significant voting power when it comes to driving the sort of social and environmental changes that their pension investors want. Australian owners driving better conditions in Australian companies.
This is another benefit which could come from UK companies being owned by UK investors. Those investors, in this case UK pensions funds, are likely to vote and drive changes which are beneficial for people who live in the UK as has been seen in Australia.
Today UK listed companies are predominantly owned by non-UK investors. Recently it was estimated by New Financial that UK owners only own 44% of the UK market. In 1989 that figure was 88% of the market.
Creating a virtuous cycle for UK plc
I believe that a greater pension fund allocation to UK equities would immediately help close the valuation gap between UK equities and other developed markets. That means share prices could rise and savers would see the value of their pension rise.
In addition to this short term gain it is also my belief that the positive effects I have described on economic growth would also flow through into the performance of UK equities. All companies would have access to cheaper capital allowing them to invest at home and abroad, potentially driving up profits. And those companies with a high proportion of sales in the UK could directly benefit from higher GDP growth and productivity gains. Higher share prices could drive better returns for pension savers meaning they may have more money in retirement.
The picture I am painting here is one of a virtuous cycle – where a recurring cycle of events, result in each one increasing the beneficial effect of the next. Building this out further, pension owners could enjoy all the social benefits that come from having a vibrant economy.
I believe there would be more jobs created and more tax revenue taken, meaning more money for schools and hospitals. A well-funded domestic equity market has clearly helped Australia and Canada and I think it is time to look at how we can emulate their success.