Chancellor Jeremy Hunt looks set to introduce the British ISA at this week’s Autumn statement. The move is designed to reverse the malaise that has set in for the UK’s capital markets, and bring investors back to UK companies. The ultimate aim is to provide support for companies to grow and galvanise the UK’s lacklustre economy. It is a laudable goal, but can it work in practice?
The UK’s capital markets are in a tough spot. The third quarter of 2023 saw just five listings on the UK main market and AIM, raising just under £360m. IPO proceeds fell 36% year on year, higher than the global average, and continuing a long-run period of weakness . A better year is forecast for 2024, but the UK is still seeing companies choosing to list abroad.
High-profile British companies such as semiconductor firm ARM Holdings have chosen to do their IPOs outside the UK, while other UK companies that are on the London Stock Exchange have considered leaving. The Quoted Companies Alliance (QCA) found that one in four UK small and mid cap businesses now see no benefit in being publicly quoted.
Charles Hall, head of research at Peel Hunt, says: “UK markets are in a deep-set malaise with a sharp decline in the number of companies, capital market activity and liquidity. UK markets are failing to support growing companies, which is leading to many selling far too early in their lifecycle.” He points to the 20% reduction in the number of small caps, 15% reduction in the number of mid caps over just five years, with 30 companies potentially leaving the market in 2023 alone.
The causes of this problem are varied. Partly it has been the general disillusionment with the UK. Sentiment has been poor post-Brexit and the economy has been weak. This has weighed on stockmarket valuations. As Simon Gergel, manager of the Merchants Trust, recently pointed out, investors pay approximately one pound for every £10 of profit generated in the UK, while on Wall Street they have to stump up $20 for every dollar. This may be good for investors, but it is tough for companies, who recognise that they could attract significantly higher valuations on different markets.
However, a greater problem has been the lack of buyers. Pension funds sit at the top of this list. UK private sector pension fund holdings of UK equities fell from over 50% of the average pension fund portfolio in 2001 to just 4% in 2022, according to research by the Tony Blair Institute. This has largely gone into UK gilts and corporate bonds, but also into global equities. Insurers, charities, wealth managers and retail investors have also moved away from UK equities in favour of more exciting opportunities elsewhere.
Will the BRISA make a difference? Hall believes it can, saying: “[A British ISA] would reverse the long-standing withdrawal of funds from the UK market and turbocharge the UK public markets”. However, he says it would need to have a small- and mid-cap focus, which is where the main funding problems currently reside. He also points out that these companies tend to be more focused on the UK domestic economy than larger companies and would therefore bring greater benefits. Over 50% of QCA members says these ISA reforms would have a ‘notable’ impact on their ability to raise capital.
There were around £68.5bn in ISA subscriptions in the tax year to April 2022, with stocks and shares ISAs making up around one third of the total. UK retail investors could not save the UK market single-handedly, but they could certainly create a new and important source of demand.
However, with the policy not even announced yet, it is unlikely to make a difference for investors in the near-term. Is there anything that could drive investment into the UK in the shorter term? Michael Browne, chief investment officer at Martin Currie, admits that while the UK is really cheap, “value without a catalyst is not interesting”.
But, he adds, “I think there is a catalyst here, in terms of much better underlying performance of the economy. There is a catalyst in terms of the consumer turning round in 2024 and 2025 and there is also a catalyst in that rates at 5.25% are probably too high and they could come back at some stage next year.”
There are those who still consider the UK uninvestable because of Brexit, but, in general, he says, UK companies have found a way to muddle through: “Politics has been unstable, but it’s not as if the UK doesn’t have a decent legal framework. There’s a huge institutional and international sentiment shift, which is still sitting in the past, which is why we have a discount to Europe. Political stability will help.” He believes the next election will be seen as a step towards that stability.
He would be supportive of a BRISA: “There is some pressure building on it.” He says it looks anomalous that the UK government has been supporting the cost of capital for businesses around the world. “There has been a move out of the UK from some of the major banks, and they have been helped in that decision by the foreign exchange movements. If sterling stopped being unpopular, that could expose a significant mismatch between assets and liabilities for retirees in the UK.”
The BRISA is not a silver bullet for UK equities. It can only be a longer-term solution to the problems of UK capital markets. Equally, there are other problems – such as cost disclosure for investment trusts and the potential impact of lowering IHT on the AIM market – that also need to be addressed to funnel adequate investment into the UK economy. However, it does suggest that the government at least recognises the problem. At the same time, there are other catalysts that may draw investors back to the UK market. After the relentless selling of the past few years, it may just be enough to turn the tide for the UK.
