March 2021 • Topic: Unlocking capital markets • by William Wright
‘Water, water, everywhere – nor any drop to drink’
The Rhyme of the Ancient Mariner, by Samuel T Coleridge
This report shows that while the UK is bursting with over £5.6 trillion in pools of long-term capital it faces a drought of the sort of long-term productive investment that the economy needs in the wake of the Covid crisis. Just 1% of pensions and insurance assets are invested in unlisted UK equities: this report highlights the barriers to unlocking more of this capital and suggests some solutions to put more of it to work in the UK economy.
As we approach the first anniversary of lockdown in the UK, the economy needs all the help it can get to rebuild in the wake of the Covid crisis. In particular, it needs more ‘productive investment’: long-term capital that is put to work in the form of equity markets, unlisted equities, growth capital, patient capital, and infrastructure investment. But does the economy have access to the sort of funding that it needs?
This paper sets out in stark terms an apparent disconnect in the UK: on the one hand, the UK is overflowing with long-term capital in the form of pensions and insurance assets. On the other, it is suffering a drought in terms of patient and productive capital, with only a tiny proportion of the abundant pools of long-term capital in the UK being put to work in the form of productive investment.
The paper analyses this disconnect by mapping the available pools of long-term capital in the UK; drilling down into the asset allocation of different ‘buckets’ of long-term capital; and mapping that asset allocation against different markets to identify how much (or how little) of that long-term capital is in the form of productive investment. It identifies the main barriers to unlocking more of this capital, and suggests some potential solutions.
In theory, investors with long-term time horizons and long-term liabilities like pensions funds and insurers should be ideally placed to provide long-term productive investment to the UK economy. In practice, we found that:
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Here is a 10-point summary of our paper on ‘Unlocking productive investment’:
1. An embarrassment of riches: the UK is overflowing with big and deep pools of long-term capital. We estimate that the combined value of pensions assets, insurance assets, direct retail investments and endowment funds in the UK is around £5.6 trillion, nearly three times GDP. This means the UK has the biggest and deepest pools of long-term capital in Europe (and in terms of depth not far behind the US).
2. A clear disconnect: only a tiny proportion of this capital is allocated to long-term, patient, productive assets. Just 12% of this huge pool of capital is invested in the UK stock market and less than 4% is invested outside of the FTSE 100. Less than 1% of the £4.6tn in pensions and insurance assets is invested in UK unlisted equities (and just 0.5% of defined contribution pensions are).
3. Growth potential: on the plus side, this presents a significant growth opportunity. Given the sheer scale of pools of long-term capital in the UK, a small shift in asset allocation could have a huge impact. If the asset allocation to UK unlisted equities across pensions, insurance and retail pools of capital increased by just one percentage point (to 2.1%) it would put an additional £55bn to work in the UK economy.
4. A post-Covid recovery: the UK economy will need all the help it can get in the wake of the Covid crisis. Companies will need more equity and equity-like funding, and the economy will need more investment in infrastructure, innovation and growth. Smaller companies in the private sector that are most likely to be hit by Covid are probably going to be the least able to access the equity funding that would help them rebuild.
5. The decline in UK assets: over the past 20 years the asset allocation of UK pensions, insurers and asset managers has fallen sharply. Defined benefit pensions schemes (the largest component of UK pensions) have reduced their allocation to UK equity from 48% in 2000 to less than 3% today (meaning that in real terms they have cut the value of their investment in UK equities by nearly 90%). UK asset managers and insurers have roughly halved their allocation to the UK stock market over the same period.
6. A minority stake: the low allocations to productive UK assets means that pools of long-term capital in the UK owns less than 30% of the UK stock market between them, around a third of venture capital and growth funds in the UK, and less than 10% of buyout funds.
7. The flow of investment: the flow of investment in productive assets in the UK is relatively low. Over the past five years, UK companies have raised about £30bn a year in equity on the stock market. Private equity firms have invested about £13bn a year in the UK, venture capital funds about £1.5bn a year and growth funding has averaged £2.5bn a year. Infrastructure investment is harder to identify because it straddles different sectors and asset classes, but we think it less than £10bn a year.
8. A structural challenge: two of the biggest challenges in unlocking more productive investment in the UK are the ubiquity of open-end / daily dealing investment funds, and the growth in passive investing. Open-ended funds account for 85% of investment funds in the UK, but are a poor vehicle for illiquid assets. The government is focused on developing a new long-term fund structure to address this. Low cost passive investing is also unsuitable for investment in illiquid assets: 30% of all assets under management in the UK are run on a passive basis, rising to 44% for equity assets.
9. The main barriers: the low level of productive investment in the UK is the rational outcome of a system that has grown in size, complexity and interconnectedness over the past few decades, and which has been repeatedly overlaid with new regulation and structures. There are also specific barriers within each bucket of long-term capital, such as the charge cap for DC pensions and capital requirements for insurers.
10. Opening the taps: there is of course no silver bullet to unlocking more productive investment. Broadly we think the government and industry should focus on getting more money into pools of long-term capital, making those pools of capital more efficient, ensuring they have right the vehicles and structures in which to invest, and recalibrating the regulatory and tax regime around them. More ambitiously, the government and the investment could work together to create a growth fund with a specific focus on productive capital.