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Craig Coben is a former global head of equity capital markets at Bank of America and now a managing director at Seda Experts.
“If you see Sid, tell him,” intoned the 1986 ad for the British Gas privatisation. Sid responded with brio as 1.5mn individuals snapped up shares that later turned a huge profit.
But 37 years later Sid cuts a more pathetic figure. He’s no longer the swashbuckling stock market buccaneer of the Thatcher years. Today he receives income from a triple-locked state pension and a defined benefit company pension closed to new members.
Sadly, even a medicine cabinet full of generic-label blue Sildenafil pills can’t rouse him to re-enter the equity market. Sid, the archetypal man on the street, suffers from mercantile dysfunction.
The decline in retail participation in the UK stock market has been a hot topic in the broader, angst-ridden conversation about reviving London as a financial hub and stanching the exodus of company listings. Policymakers and City of London grandees are pondering ways to rekindle risk appetite among the British public.
Against this backdrop, the New Financial think-tank published this week a thought-provoking report entitled “Widening Retail Participation in the Equity Market.”
According to the research, the percentage of UK households holding equities has nearly halved in the last twenty years, while the portion of the stock market owned by individuals has remained stagnant over that period. The only consolation is that the equity ownership figures are pretty dismal in other European countries, except Sweden.
The report presents several sensible ideas to promote direct share ownership, such as better public education, targeted tax incentives, greater use of technology, and removal of investment barriers. These ideas warrant serious consideration in the run-up to the Chancellor’s Autumn Statement.
The stakes are high because higher equity market exposure could enhance financial security and wellbeing for the general public, while also channelling idle savings into potentially more productive uses. Amid the flurry of recommendations and reports, it is worth stepping back and examining why retail investors have abandoned the equity market.
For starters, it’s worth noting that many of the measures that have been proposed or trial-ballooned — better access to broker research, more generous tax allowances, the removal of stamp duty — will primarily benefit those already active in the market who are often financially well-off. These measures will help, but mostly at the margins. These are the same investors that invest in run-of-the-mill IPOs and other share offerings.
A harder nut to crack involves reaching the larger pool of potential investors who have some resources but minimal or no exposure to the equity market. Given the low average savings in the UK, these individuals tend to be understandably risk-averse.
Historically, middle-class investors in the UK have invested in equities through “with-profits” funds, often tied to pension products or residential mortgages. These policies aim for a “smoothed return” to avoid nerve-jangling mark-to-market volatility. However, they have fallen out of favour due to their opacity, illiquidity, and potential conflicts of interest in apportioning returns between policyholders and insurance companies, mostly famously coming a cropper in the Equitable Life scandal. Moreover, Solvency II regulation renders the product less viable by forcing insurers to invest in bonds to match liabilities, thus foregoing the superior long-term returns from equities to assuage regulatory concerns about a possible capital shortfall.
It’s a similar story with pensions. Solvency rules triggered a reallocation from equities to bonds, while changes in tax rules for fund surpluses increased the effective tax rate on company pension schemes, making it harder to smooth equity returns. Meanwhile, dividend income to pension funds face higher taxes following the abolition of the dividend tax credit in 1997. (I’m referring to company-funded DB pension schemes; a “defined contribution pension” isn’t a pension, as the dictionary defines it: it’s an at-your-own-risk investment product with tax relief.)
As a result, unit trusts and, more recently, exchange traded funds have become the primary vehicles for average retail investors interested in equities. But both face headwinds to mass adoption. Unit trusts have a high expense ratio acting as a drag on returns, notwithstanding regulatory pressure on providers to lower the fees. As for ETFs, they offer a cheap-and-cheerful way to track an index, but low commissions mean that financial advisers scarcely market ETFs to their clientele. “Financial products are sold, not bought,” as the old saying goes.
The upshot is that the UK has effectively discouraged the average investor from investing in UK listed equities through smoothed-return products, such as with-profits policies or pension funds. One can understand why successive governments have taken that approach: first, they want to protect policyholder claims against the failure of an insurance company or pension provider; and second, they have an insatiable, Scooby Doo-like appetite for tax revenues to close the UK’s yawning fiscal deficit. Moreover, the civil servants who have enacted these restrictive rules don’t have a vested interest in capital appreciation in pension schemes; after all, they stand to receive unfunded but government-guaranteed inflation-linked pensions.
Today, politicians are realising that retail investors barely figure today in the stock market. And this has aggravated London’s woes when combined with an IPO drought, the decline in the number of listed companies and deteriorating trading liquidity. The government wants to rejuvenate London as a listing exchange, but policy remains muddled and compromised by budgetary pressures: it has, for example, recently reduced the annual capital gains tax exemption and the dividend allowance. That’s not the way to nurture an equity culture.
Sid’s withdrawal from the stock market represents the inexorable outcome of policy choices going back several decades. While each policy may have seemed rational at the time, the cumulative long-term effect has been to drive individuals away from equities. Now after two decades of UK equity underperformance, it will take some time — and more coherent policy thinking — to restimulate retail interest in the market.
