Comment

Foreign invasion

The takeover of Cadbury is a sign of things to come as domestic investors lose control over the UK equity market warns Lindsay Tomlinson, NAPF chairman

The ongoing decline of defined benefit (DB) pension schemes has been widely documented and commented upon. It is only those in authority that do not appear to have noticed.

But I think there are even more important investment consequences which are immediate and which are deeply damaging to the UK economy. And even worse, no one seems to recognise them, let alone be taking any mitigating action.

Iconic British company
We have just witnessed an emotional and heated debate about another iconic British company, Cadbury, falling into foreign ownership. The arguments have largely been about British jobs. The prevailing stock market view has been that the takeover is a natural result of globalisation. This, however, is by no means the full story.

Back in the good old days, the UK was home to a large group of long term investing institutions, mainly life assurance companies and pension schemes that took a long term view of investing and invested heavily in equities, most of which were in the UK market. Holdings in international equities were minimal before the abolition of exchange controls in 1979. Way back then, UK savers both financed and controlled British industry through their equity investment policy.

In those circumstances it would have been rational for politicians to berate UK investors for letting an iconic British company fall into foreign ownership. Curiously enough they did not. Such happenings were regarded as part of a process of globalisation, from which we would all benefit. And the existence of the big domestic long term investing institutions was a crucial component of the development of London as a global financial centre.

However, one of the major drivers of change in company share registers has been the application of mark-to-market accounting and solvency standards to long term investing institutions. Quite simply, when these standards are applied to life assurance companies and pension schemes, the proportion of their assets invested in equities is bound to fall. They are no longer able to take the long view. For pension schemes the effects have been even greater because marking-to-market has forced them out of equities and denied them the opportunity of earning the hotly debated equity risk premium, thus pushing up the expected costs of the benefits they seek to provide. In turn this has accelerated pension scheme closure, further reducing the funds’ equity investment potential.

As a result the traditional long term investing institutions no longer dominate the UK equity market. Domestic pensions schemes now own about 13% of the equity market. Adding in the life assurers takes it up to 25–30%. Overseas investors already hold much more and the proportions held by domestic investors will continue to fall. These changes are important. Quite simply, in our current regulatory and accounting regime, there is no natural domestic buyer of UK equities. Despite this, UK investors participated in a major recapitalisation of British companies in 2009.

So the decline in DB pension schemes is not just a problem to worry about in 20 or 30 years’ time. It is already having a considerable impact in the equity market, with major consequences for the UK economy.

It would be possible to address this problem by, for example, facilitating pensions risk sharing and by backing away from marking long term institutions to market. But if the powers that be do not take mitigating action, expect UK companies to be majority owned by foreign investors, for better or worse. You have been warned!

Lindsay Tomlinson is chairman of the National Association of Pension Funds;
lindsay.tomlinson@blackrock.com