Market Update 11th March 2024

The Great British Isa – will it work?

The policy that caught my eye in last week’s budget was the Great British ISA. The details are yet to come, but it looks as though investors will receive an extra £5,000 of ISA allowance (a 25% uplift) to invest in UK businesses.

I am wholeheartedly behind ideas that boost personal savings and engagement with financial markets. The reasoning is simple. The average investment portfolio has historically outperformed cash over most 3-5 year timeframes. Over longer horizons, that outperformance only gets more prominent. Of course, there are no guarantees attached – but I still think encouraging more savings into the market is one of the easiest and cheapest ways for governments to make people better off over the long term. Markets have historically done a wonderful job of creating and enhancing wealth.

However, the Great British ISA itself is not designed with wealth creation in mind. Instead, it has been drafted to try and prop up valuations in the very much unloved UK market. Investment Association data shows retail flows into UK funds have been negative in each of the last 8 years. Political instability (one party, but five prime ministers) and the uncertainty around the implementation of Brexit have both weighed on sentiment.

However, underlying performance has been strong. Since those outflows began in 2016, UK dividend payments are up, even after many companies reset during Covid. Earnings growth is very good too, having risen 62% over those same 8 years. By 2026, earnings per share could very well have doubled from that 2016 base. While the UK might not have the glitz and glamour of the US or the Far East, this proves it is home to very good, and resilient businesses. With the price of the assets themselves not keeping pace with earnings growth, these robustly profitable businesses are significantly cheaper than they have been for many years. The valuation of British businesses down by around 25% on a price to earnings (PE) basis.

This has not gone unnoticed. American private equity firms are swooping in to buy up UK businesses. And even when there isn’t a buyer, UK firms are moving to set up shop across the pond because listing in the US gives access to more capital and often generates a higher valuation. Those departures are not being offset by more listings either. In fact, 2023 was another multi-year low. The net effect is a drain of London’s capital.

Will the possibility of an extra 25% in ISA pots make a difference? Of course not. At the risk of this article becoming completely arid, I again turn to the numbers. The latest figures, for 2020–21, show about 1.6m people maxed out on subscriptions. And that’s when people were throwing money into the market… 2021 was the second strongest year for retail inflows this century, according to our friends at the IA. If we generously assume the same 1.6m max out and put the extra £5,000 in, that would create an extra £8bn inflow.

But they won’t. And that also assumes those maxing out are all investors, not cash savers. This is likely very wrong – historically Cash ISA subscriptions exceed Stocks & Shares ones. And of the money that does go into Stocks & Shares ISAs, a rather large percentage is not new money. It is just moved from other taxable accounts.

So, let’s assume half of those 1.6m people only do a cash ISA, and half of the remaining 800k can’t or don’t make the most of the new rules. Finally, let’s assume that half of the remaining lot are just moving existing assets. That leaves us with 200,000 people, or £1bn in new money. Even if these assumptions are underestimating the impact by half, it’s still only £2bn.

For context, auto-enrolment generates around £74bn of net flows a year through mandatory pension contributions. While I accept that only some of that £74bn is flowing into UK equities, the amount that is will be significant. If that hasn’t helped UK equity valuations, or made London more appealing for new listings, I’m not sure the extra ISA allowance will.

So, if this policy doesn’t move the dial, where does it leave us?

Well, actually in a rather exciting situation. Plan A is for the UK to come back into vogue while earnings continue to progress. This would obviously be very conducive to positive returns. But it is not guaranteed. So, let’s look at the bear case. Valuation could continue to drift down. This is possible, but I think it stretches credibility over a multi-year view. As above, takeover buyers are already getting their chequebooks out, and interest rates, which generally move inversely to valuation, are forecast to drop rather than increase. But perhaps the biggest safety net is that another 25% dip in the next 8 years would leave the market’s PE on a par with the depths of the 2008 financial crisis. Even in that scenario, and assuming earnings and dividends grow by just a third of the pace they have done since 2016, an investment today would theoretically breakeven.

It is foolish to predict anything with certainty, and history tells us seemingly uncorrelated macro headwinds have a nasty habit of coinciding when they arrive. But for a patient investor, it does feel that something needs to go very wrong for this not to be a good long-term entry point.

George Salmon – Senior Investment Analyst

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