Public sector pension consolidation, the Mansion House Compact and the recent of the Private Intermittent Securities and Capital Exchange System (PISCES) should facilitate institutional investment in UK companies over their long-term investment horizons. It is a starting point for rebalancing UK pension funds’ risk tolerance in line with their global counterparts. The Labour government has stated its willingness to intervene if these measures do not drive a sufficient improvement in pension funds’ domestic bias[11].
Changes to “Value for Money” rules – to focus on net returns, instead of solely on cost – should also support capital flows into parts of the market where active management adds value. In 2023, there was only one local government pension scheme with an allocation to UK smaller companies[12].
2. Greater retail participation
The rise of the ‘Magnificent Seven’, capital flows into passive investments and comparatively lacklustre UK GDP growth have driven retail investors to invest a greater proportion of their assets globally.
Portfolio diversification is, of course, rational, but the current UK tax structure creates no incentive to invest domestically: investors have total flexibility in
their investment options within their pensions and ISAs, with their respective income and capital gains tax reliefs; stamp duty is payable only on UK shares so actually incentivises investment overseas; and the UK is the only country in the world to give a tax incentive for cash saving!
Labour is committed to simplifying the ISA regime to encourage investment[13]. There have been a number of changes proposed by the industry, such as merging cash ISAs and stocks and shares ISAs[14]. Greater retail participation disproportionately benefits smaller companies[15]. We only need some of the £350 billion currently sitting in cash ISAs to be reallocated to equities to make a big difference.
3. Investment research review
The unbundling rules for research payments, introduced under MIFID II in 2018, have disproportionately impacted sell-side research coverage of UK smaller companies. Consolidation of UK research providers has resulted in poor breadth and depth of coverage for smaller market capitalisation stocks[16]. As of August 2024, however, the FCA has reversed these restrictions, making it easier for companies to procure research and, importantly, widening access to it.
For more on all of the issues covered above, we recommend an excellent podcast by Charles Hall at Peel Hunt, Dame Julia Hoggett and Charlie Walker of the LSE[17] and CMIT’s Capital Markets of Tomorrow report for further reading.
Clear political appetite to reinvigorate the UK’s capital markets
“Growth is the number one mission of this government,” says Minister for Pensions Emma Reynolds. “If growth is the challenge, then investment is the solution.”
Although there have been a few false starts this year – hopes of a British ISA and of minimum allocations for pension funds in UK equities are yet to come to fruition – there is a clear ambition to address any systemic barriers to the competitiveness of UK capital markets.
Reform remains high on the political agenda, evidenced by LSE CEO Dame Julia Hoggett, who summed up City Minister Tulip Siddiq’s intentions as: “All the things that you as an ecosystem liked that the previous government was doing, we are going to finish. All the things you liked that you didn’t think they were doing fast enough, we are going to go faster. All the things you liked that you didn’t think they were going to do, we are going to do[18].”
The siloed nature of the UK’s regulatory landscape requires concerted effort from numerous stakeholders to affect change. Although we don’t expect one thing to be the sole catalyst for UK equity outperformance, recent wins are significant and momentum appears to be building. Outflows are stabilising and higher volumes of risk capital should have an important waterfall effect, driving demand for and improving liquidity in UK small and micro caps. As with all market turning points, it may not appear obvious at the time, but it is incredibly clear in hindsight.
