THE CITY GRUMP

Why aren’t we investing enough in British companies so that they can up their game on growth? Well according to the great and the good , it is because those pesky pension funds don’t invest enough in equities and invest far too much in bonds.

This is reverse ferreting on an epic scale.

Until a few months ago everyone from the pensions regulator to the FCA and legions of actuaries were telling pension fund trustees that the only way forward was to pour ever increasing amounts of our pension contributions into government bonds. Never mind interest rates had fallen to near zero because in the brave new world of the Bank of England’s economics those rates would stay on the floor for ever and ever so bonds were a nice safe bet. Others such as I, Tim Congdon and Anthony Hilton had been warning for years that this was nonsense on stilts and there would be a terrible day of reckoning when the boys and girls in the fixed interest markets realised inflation was back in town. What happened in the second half of last year and since then has been well-documented and suffice to say that with the quadrupling of interest rates, the pension funds have lost billions of net asset value and the financial establishment has been left looking very foolish indeed.

But, lo and behold, the financial establishment in their infinite something or other, has now declared it was all very silly to invest in those nasty destructive bonds and the time has come to urge those benighted pension fund trustees to compel their fund managers to invest in so-called risky UK equities, so that the capital is there to turbo charge our fledgling growth companies onwards and upwards, thus enabling our Country to break into the sunlit uplands of a materially growing economy. Thus, we have the new head of the pensions regulator, Nausicaa Delfas (yes that really is her name), trumpeting that “no saver should be in a poorly performing scheme that doesn’t offer value for money. Where we find poor performance, the message is clear: wind up and put your members in a better scheme. Or we will consider all powers at our disposal”.

Never mind that those self- same powers were used to push those funds into disastrous bonds that led to poor performance. This breath-taking  reverse ferret has been added to by the hapless Andrew Bailey at the Bank of England who, this month, said the UK had become too focused on “low yielding assets, such as bonds, and ignoring investments that could generate higher returns for savers”. The Sage of Threadneedle Street, warming to his Damascene conversion, went onto say:

“We’ve got to think about what is the right structure and operating model for that world to get the right balance  between saving, risk-taking and productive investment”.

So far, so U-turn, but then he lobbed in a financial grenade when he suggested: 

“We have probably got too many small pension funds. The problem with that is that there are not economies of scale in risk management. The smaller the fund, the more the pressure to have something that is simple to manage but doesn’t actually have sensible diversification”.

The big is beautiful chant seems to be gaining momentum with that well known financial genius and all-round good egg, Sir Tony Blair urging all pension funds should be merged into just six £400bn superfunds” to turbocharge  investment in businesses and infrastructure. According to the Telegraph, the children at the Treasury are attracted to this sort of thing with about 4,500 of the smallest defined benefit schemes being offered the chance to merge into the Pension Protection Fund (PPF), creating a behemoth known as GB Savings One.

This big pension fund idea is madness and totally illogical. We now have the great and the good saying these mega funds must invest in upcoming growth companies but the maths simply doesn’t work. If you are running a £400bn, or a £40bn, or even a £4bn fund you cannot get enough money into a £10m or even £100m company to make a difference to your performance that Nausicaa finds so essential.

Let’s use the example of a lowly (according to T. Blair, etc) £4bn fund wanting to invest in £100m market cap companies and let’s say you allocate 40% of your net asset value to investing in those companies. The trustees probably, and understandably, would want to  limit each investment to 10% of a £100m company. Accordingly this means the fund would have to invest in 160 companies, or 1,600 companies if it was a £40bn fund or 16,000 companies if it was a £400bn fund. Any fund manager who has been around for more than a few minutes will tell you (a) finding  so many companies and then keeping tabs on them is for the birds and (b) such diversification will put a major damper on performance.

Nuts.

Consolidating and corralling pension funds into investing into much needed UK equity investment cannot work, so what could? It has almost been forgotten that the “Tell Sid” advertising campaign for the launch of British Gas onto the London Stock Exchange in 1986 was hugely successful in getting the public to participate in equity investing. By the end of the 1980s 20% of UK adults held individual shares, whereas a decade before it was just 7% of adults. This number has now fallen back to 12%. The maths irrefutably point to the private or if you will the retail investor together with smaller investment funds, as being the only realistic sources of capital that are capable of that much needed UK equity investing that the great and the good have finally come round to identifying. But Sid has been virtually ignored for at least the last two decades.

What must now take place is an extensive advertising campaign together with social media messages, which reconnects Sid to the virtues of equity investing.  The very essence of an equity is to create rising income streams whereas the essence of a bond is to provide flat income. It cannot be beyond the wit of the London Stock Exchange to get this and many other positive facts across to Sid again. The question is does the LSE have the oomph to do so and thereby help this Country to really grow again? It has a feisty new CEO in Julia Hoggett, so let’s hope so.

The City Grump has spent some 40 years in the City of London. He started as a stockbroker’s analyst but after some years he decided he was too grumpy to continue with the sell side of things so he moved to the buy side and became a fund manager for the next 20 years, selling his own business in the 1990s. Post the millennium, he found himself in turn chairing a stockbroker, a financial PR company, and an Exchange. He still keeps his hand in, chairing a brace of VCTs and investing personally in startups. The City Grump’s publications are available here.