Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Individual investors are increasingly of the opinion that they should use open-ended collective investment schemes such as mutual funds to invest in equity markets, rather than investing directly in the underlying securities.
The rise in the popularity of passive funds has exacerbated this herd mentality which has led to a significant collapse in direct retail participation in UK equity markets.
Since 1963, UK retail investor participation in Britain’s equity markets has fallen from 54 per cent to 10.8 per cent in 2022, according to figures from the Office for National Statistics. While part of the reason has very likely been that US markets significantly outperformed the UK over the past decades — and this cannot be ignored — it doesn’t tell the whole story.
I believe successive British governments bear a good deal of responsibility for what has happened. Following pressure from large institutional investors, both in the UK and the EU, they have used tax policy to encourage retail investors to put money into collective investment schemes and out of direct investment.
These investors, however, have very little say in the running of the companies contained in their funds, unlike direct shareholders. This is a troubling phenomenon when it comes to the investor-investee relationship and the governance of UK business.
Best of Money Clinic: Investment masterclass with Deborah Meaden
Dragons’ Den’s Deborah Meaden speaks to host Claer Barrett about how she picks which companies to invest in, her commitment to green investment and her latest book, Why Money Matters, which explains money and finance to children. Listen here
Investors are attracted by tax incentives for collective investment schemes, such as the lack of VAT payable on the annual management charge; the ability to reduce the amount of stamp duty of 0.5 per cent by the proportion of the fund not invested in UK equities; and, for qualifying collectives (most of them) freedom from an annual, complicated obligation to report gains and pay capital gains tax (CGT) regardless of profit or loss. The CGT issue has become increasingly unfair over the past few years, with the annual exemption being repeatedly cut, and set to be cut in half again.
In addition, most investors who follow this fund-based consensus do so because of the convenience of buying a pre-packaged investment product from a regulated product manufacturer. However, governments have failed to understand that direct ownership of companies is central to capitalism and retail investors play a significant role in the health of their domestic market and holding business to account.
With the retail investor base gradually switching to include ever more Gen Z and Millennials, this is likely to matter even more. As intellectually and socially diverse generations, they are a powerful force; they believe in taking action, holding both themselves and others to account. They also expect the corporations with which they interact as shareholders, consumers and employees to be equally proactive.
On the other side of the coin, most investors in equities through funds have very little idea which companies are held, let alone the value of their stake in each, nor do they have a role to play.
Another blow for the retail investor community came with the government’s legislation on the rights of nominee holders at the implementation of Crest, an electronic settlement system, in 1996. This disenfranchised them and created a three-tier model where nominee holders are essentially third-class citizens deprived of many of their rights, such as automatically receiving reports and accounts, the notification of any material event, the right to vote their shares and the right of pre-emption, which entitles them to buy new shares ahead of other investors.
This has all meant a breakdown in the important link between retail shareholders and UK plc.
It is disappointing that no one in the government appears to have given much thought to the damaging effect on retail investor behaviour of using tax policy to encourage institutional fund investment over direct investment. It has failed to protect the many rights that retail investors have lost, to the benefit of the investing institutions.
The government needs to take a wholesale look at its policies relating to retail investment. Reigniting it will benefit UK business and the UK economy as a whole.
Paul Killik is founder and senior executive officer, Killik & Co
