Irregular Roundup, 10th July 2023

We begin today’s Weekly Roundup with diversification.

Diversification

The Economist worried that American investors love American stocks too much.

American fund investors hold just a sixth of their equity allocation overseas. Jack Bogle, who invented index funds, called international exposure an overcomplication. Warren Buffett thinks his wife should allocate 90% of her wealth to the S&P 500, and 10% to Treasuries after his demise.

Harry Markowitz, who popularized diversification (but did not himself entirely stick to the rules of his portfolio theory) died last month.

Diversifying holds benefits at all levels of portfolio construction. Within stocks, investing in many firms is better than holding a few; across assets, holding stocks, bonds, real estate, commodities and so on is better than holding one or two assets. And holding these assets in many countries is preferable to just one.

But Americans love America, and use a variety of reasons to justify their home bias:

• American firms are multinational.
• Growth tends to move in sync across the globe.
• There are risks that volatility in returns cannot capture.
• No portfolio manager will be fired for buying American. 

The main reason is that US stocks have outperformed in recent decades.

Since 1990 America has on average returned 4.6 percentage points more per year than a broad index of rich-world stocks. Even though America only makes up 25% of the global economy, its stocks count for 60% of global market capitalisation.

According to Cliff Asness at AQR, most of the outperformance comes from high valuations:

Of the 4.6% premium, some 3.4% exists because price-to-equity ratios in America are higher. Just 1.2% comes from fundamentals.

This means that it’s probably time for Americans to look abroad.

Listing reforms

In the FT, Chris Flood reported on complaints from pension schemes that the FCA’s plans to attract more companies to list in the UK by reforming listing regulations would damage the City’s attractiveness as a global business centre.

• Ten of the largest schemes – which look after £300bn of assets between them – wrote an open letter to the FCA, warning that the reforms would damage“fundamental investor protections”.

These are industry schemes (such as Railpen and the Universities Superannuation Scheme), so most of us won’t know much about them, but Nest (which I use for the company I run) was on the list

Listings on the London exchange have fallen by 40% since 2008, but the pension schemes worry about the dilution of shareholder rights (in particular those of institutional investors, making it difficult for them to act as stewards).

• They are particularly concerned about the right of shareholders to vote on significant
  transactions (such as a takeover by a related party).

The key proposals are:

• removing the requirement t for companies to have three years of audited accounts
• merging the standard and premium markets
• giving company founders greater voting rights through the use of dual-class share structures.

Michael Marshall of Railpen said:

We do not think that the proposed changes will solve the fundamental issues affecting our equity markets. Rather, we think that they will amplify the current challenges as well as leading to worse outcomes for our members.

Maria Espadinha of the Pensions and Lifetime Savings Association (and formerly of the FT) said:

The new rules run the risk of having a contrary effect to what is hoped for, by potentially reducing the pool of institutional and retail investors willing to invest in UK-listed companies.

But Andrew Griffith, the City of London minister, pointed out that the schemes already invest in other markets with similar rules:

We value the views of counterparties — it’s a delicate ecosystem. However, what we are seeking is a level playing field [with other listing venues]. We’re not looking for novelty.
Those same companies and same funds . . . will happily go and invest in overseas markets without holding them to the same standard of governance.

LSE CEO Julia Hoggett also defended the reforms:

The vast majority of those institutions that are saying ‘We don’t want change’ direct more
of their pensioners’ money into companies listed overseas, that have exactly the rules
that the FCA is trying to move to, than they do into UK companies. 

We need to make sure that we have a level playing field for companies to choose where
they want to get access to their capital . . . There is no point in having a theoretically
perfect market that people don’t use.

I think this is a bit hypocritical from the pension companies, but at the same time, the reforms won’t save the London market.

• Given a choice of places to list (which arises from the developments in communications technologies over recent decades), founders will want to be where the risk appetite is.

And the political climate in the UK over recent years suggests that that won’t be in London.

Fractional shares

In the FT, Claer Barrett argued that fractional shares should be permitted in ISAs.

• The problem for investors with small accounts is that major US shares cost so much.

At the time of writing, a single share in Mastercard is $380 (around £300). It’s a similar story for other US stocks whose omnipresent branding makes them highly popular with new investors all around the world. Amazon currently trades at $129 (£102) per share; Apple at $189 (£150); Tesla at $256 (£203); McDonald’s at $291 (£231) and Disney at $89 (£70).

Claer thinks that smaller investors should have access (via fractional shares “free” trading platforms like Trading 212 and Freetrade), and Lisa Laybourn of The Investing and Saving Alliance (Tisa) agrees:

[HMRC legislation] has the potential to create two tiers of investors — those who have enough money to create a globally diversified portfolio, and those for whom the door is locked because they don’t have enough money, and we don’t think this is fair.

Unfortunately, HMRC says:

Fractional shares cannot be held in an Isa. Isa managers must make sure the investments they offer are Isa eligible.

The relevant act dates back to 1998, long before phone trading apps existed.

As usual, the FT is worried about “the youth”:

What message are we sending out to the next generation of investors if accounts are closed and fines threatened? Learning how to invest is a valuable life skill. Getting to grips with this in your 20s and 30s provides a foundation of knowledge that can be built on as they manage their portfolios in decades to come.

We should praise investors who discover the benefits of Isas at a young age, not threaten to penalise them for only being able to afford fractions of shares.

That much is true, but I’m not sure that the larger point holds water.

• If you have a small account, you probably shouldn’t be buying small pieces of individual stocks.

I would recommend ETFs only for anyone with less than £100K in their account.

• You can easily achieve global diversification with a small number of funds in a small account.

Premium bonds

The interest rate (lottery pool size) on Premium Bonds is going up again.

• From August 2023, the rate will be 4% pa, rather than the current 3.7%.

The fund size will increase by £30M and there will be another 460K prizes.

• So the odds of a single bond winning will fall from 1 in 24K to 1 in 22K.

NS&I CEO Dax Harkins said:

Premium Bonds are one of the nation’s favourite savings products and I’m delighted that we’re able to improve the odds to the best they have been in almost 15 years, with more prizes, more excitement and more life changing wins for savers up and down the country.

Triple lock

Before next year’s general election, all major parties have indicated that the State Pension triple lock will remain in place.

Work and pensions secretary Mel Stride told a radio show:

I’m confident. It’s not for me to write the manifesto on air, but I think it almost certainly will be.

And a spokesman for Keir Starmer said the party was committed to the pensions triple lock, which would feature in their manifesto.

A Liberal Democrat spokesman said:

The Liberal Democrats introduced the pension triple lock in 2010 and we committed to keeping it in every manifesto since then. We opposed the Conservative Government’s appalling decision to break it, costing pensioners hundreds of pounds a year, and we remain totally committed to the triple lock now.

Fiscal drag

HMRC has published new estimates of how many people will be affected by fiscal drag (the stealth tax arising from the freezing of tax thresholds and allowances).

• The number of additional rate (45%) taxpayers in 2023-24 will rise by 55% to 862K
• The number of higher-rate (40%) taxpayers will increase by 6%  to 5.6M

The big rise in 45% taxpayers comes from the reduction in that threshold from £150K pa to £125K pa.

• The number of higher-rate taxpayers has increased by 29% since the tax bands were frozen in 2021.
• The number of additional-rate taxpayers has increased by 142%.

An extra 700K people over 65 will now pay tax, a total of 8.5M people.

• That’s two-thirds of all pensioners, up from half three years ago.

The number of tax-paying pensioners has now doubled since 2004/05.

Steve Webb of LCP said:

The surge in the number of pensioners paying income tax shows that the policy of freezing tax thresholds is really beginning to bite. The number of pensioners paying tax will continue to increase rapidly in years to come, particularly if inflation remains relatively high and thresholds continue to be frozen.

The freezes also mean far more people now paying a top tax rate of 45% which was previously intended only for the very richest. There’s every chance we could see a million people paying the highest rate of tax next year. That’s quite a seismic change in the tax system.

The Treasury said:

Our tax system is helping to restore the public finances in the fairest way possible, with those earning the most bearing the most burden.

Ironically, the freeze on the nil-rate personal allowance means that the share of tax paid by the top 1% is expected to fall, from 29,1% (in 2020/21) to 28.5% this year.

Quick Links

I have six for you this week, the first four from The Economist.

1. The Economist asked Can anything pop the everything bubble?
2. And warned that Erdoganomics is spreading across the world
3. And asked Can a viable industry emerge from the hydrogen shakeout?
4. And explained The real problem with Britain’s water companies.
5. UK Dividend Stocks explained How to find quality dividend stocks with enduring core businesses
6. And Alpha Architect was Examining Alternative Value Metrics.

Until next time.