RUTH SUNDERLAND: UK pension funds can save our stock market

Everyone in the City is worried about the way the London stock market is losing its shine.

This isn’t just a concern for a few wealthy people on the Square Mile. The health of our national stock markets affects our pensions and ISAs, as well as being a vital source of capital for businesses large and small.

UK pension funds are part of the problem. They are the trustees of around £2 trillion of assets held on our behalf, which could be used for the benefit of society as a whole, not just members of pension schemes.

But they only invest a small proportion of this in UK shares. This raises the question of whether they should be encouraged to do more and, if so, how?

Twenty-five years ago, pension funds allocated more than half their assets to UK shares, according to a report last month by research group New Financial.

That figure has fallen to just 4.4 percent, well below levels in most other developed markets. In the United States, for example, pension funds have placed 44 percent of their total assets in their country’s stock market.

It’s not a direct comparison, because the US markets dwarf ours in scale and performance. Still, it’s a big difference.

In recent years, UK pension funds have been diverted towards bonds under the mistaken assumption that they are “safer”.

They have also made more inroads into overseas markets, perhaps understandable given that the annualized total return on UK shares over the past decade has been 5.3 per cent, less than half that of global shares. The exodus from pension funds is fueling a vicious cycle in which lower demand for UK shares drives down values, further reducing demand.

New Financial estimates this has sucked around £25bn a year out of the market.

Pension funds have a general duty to their members, so they fear potential poor performance. But they could increase their allocation to UK stocks without taking undue risk.

They could double it and still be within historical and international norms. And even a small return to domestic equities by UK pension funds could have a big positive impact on the market.

If funds invested more in UK shares, there would be huge potential rewards for society.

It would create value by making capital available to companies, promote healthy markets and greater shareholder ownership. It would mean that long-term investors would have a stronger presence and a more effective counterbalance to short-term hedge funds and the like.

There is a purist view that the only obligation of pension funds is to their members, not to society as a whole. However, given they receive £50bn of tax relief, many would say they should show social responsibility.

How could Labour, who say they are interested in boosting the stock market, encourage them to invest more in UK shares?

New Financial has some suggestions. One is simply to collect more contributions from members and their employers. Increasing the amounts saved would help more people have a secure retirement and make more money available to the funds, some of which could go into UK shares. Then there is consolidation, or bringing together small schemes so that they have more power to invest. I would add a third “C” to contributions and consolidation, namely tax concessions.

Getting rid of stamp duty on UK share purchases is a no-brainer. And what about reversing Gordon Brown’s raid against the dividend tax credits that did so much damage to our once-golden pension system?