Total assets under management and advice fell by just 1% overall, from £500bn to £494bn, with growth in interactive investor and its Adviser platform partially offsetting outflows.

Net operating revenue fell by 4% year-on-year to £1.4bn as a result of both outflows and “adverse markets”, according to the company, while adjusted operating profit was 5% lower at £249m. The business’s cost-to-income ratio remained unchanged at 82%.

Investments arm

Adjusted operating profit in the investments arm of the business shrunk by 62% in 2023 compared with the previous year, by £80m to £50m. This was the result of 17% less revenue, but Abrdn said this was “party offset” by an 11% reduction in costs.

Gross flows in 2023 fell by 15.2% from £59.3bn to £50.3bn, which Abrdn said was owing to the uncertain market environment and its impact on investor sentiment.

Performance of mandates also suffered, with 42% of products outperforming their benchmarks over three years to the end of 2023, compared to 65% to the end of 2022. The firm said this reflected a “challenging period for active managers” and said its equity funds were particularly hard hit, owing to AUM bias towards Asia and emerging markets as well as its quality-growth investing style.

The investments arm of Abrdn’s business has suffered lacklustre performance over recent years and has subsequently been undergoing a “transformation plan”, with the firm announcing 500 redundancies amid stubborn outflows earlier this year. The company has also been merging or closing some of its funds and investment companies to stem outflows, including folding GARS into its Diversified Assets suite of products in July 2023.

See also: Abrdn confirms 500 redundancies in cost-cutting ‘transformation plan’ amid £12.4bn outflows

CEO Stephen Bird aims to reduce business costs by at least £150m by the end of 2025 compared with last year, with 80% of these savings coming from the investments business alone. Implementation costs are expected to reach £150m and will largely take place throughout the course of this year, with the group’s adjusted operating profit expected to be £60m lower by the end of this year.

Interactive Investor and Adviser

However, Interactive Investor, which Abrdn acquired in 2022, saw its net operating revenue increase by 43% from £201m to £287m, with adjusted operating profit ticking up 58% in 2023 to £114m, compared to £72m in 2022. Net customer growth increased by 4% while net flows stood at £2.9bn.

Meanwhile, its Adviser platform experienced a 21% rise in net operating revenue to £224m from £185m in 2022, due to higher income from Treasuries. Adjusted operating profit also increase by 37% to £118m, although inflows – including into its model portfolio service – dropped by 12%.

Commenting on the group’s overall results, CEO Bird said: “We have continued with our determination to build a modern investment company that is capable of thriving in a changing marketplace. In January of 2024, we took the next step in that process, announcing a £150m cost transformation programme to accelerate the delivery of a more sustainable cost base that can support appropriate long-term profitability. The need to continue applying downward pressure on costs was underlined by another challenging year.

“Throughout 2023, the ‘higher for longer’ rate environment across developed economies put sustained pressure on most asset classes, and while the market now expects a reversal over 2024, there is no doubt that we have felt the effects in our Investments business. The upside is the impact higher rates have had on income in Adviser and ii, underscoring the benefits of our diversified business model, which delivers through the economic cycle.”

He added: “When we embarked on our transformation journey back in 2021, not many would have foreseen the level of global economic and geopolitical turmoil we have since experienced. That has inevitably hindered our progress, and directly impacted performance.

“Nonetheless, we have moved at pace to evolve the business and create a model that is better suited to the modern investment landscape, better aligned to the products and services clients will want in the coming years and better positioned for future growth.”

This article was written for our sister title Portfolio Adviser

Earlier this week, Legal & General Investment Management (LGIM), which houses the sector’s largest Property Authorised Investment Fund (PAIF) at £1.3bn, proposed transitioning the fund towards a hybrid investment approach, opting to hold up to just 45% in direct property and 45% in Real Estate Investment Trusts (REITs) to hedge against illiquidity risk. The remaining 10% will be held in cash.

James Crossley, LGIM’s UK head of wholesale, said the transition would be “in the best interest of investors” and recommends that they vote in favour, ahead of a shareholder meeting in April. He added: “As a property sector leader for over 16 years, we are well positioned to continue providing balanced property exposure to investors.”

“Relative to other asset classes, we feel that the UK property sector remains an attractive diversifier in any balanced portfolio, and is well positioned for investors with long-term horizons.”

The changes were first openly discussed in November last year, weeks after M&G announced it will wind up its £565m open-ended property portfolio due to “declining interest in open-ended daily dealing property strategies” from UK retail investors. Just one day later, Canada Life shuttered its PAIF after assets under management (AUM) more than halved from £254m to £102m, leaving it “no longer commercially viable”.

Direct property funds have suffered a torrid time over recent years, having been forced to temporarily close after the UK’s EU referendum and during the pandemic to stem outflows, which would have otherwise overtaken the funds’ ability to sell assets and thereby return capital to investors. The number of PAIFs in the Investment Association have slowly dwindled, with Aegon and Aviva taking their offerings off the market in 2021, and Janus Henderson liquidating its strategy in 2022.

The struggles faced by the sector led to a consultation by the FCA on the “liquidity mismatch” of open-ended property funds in 2020, which resulted in the regulatory body creating the Long-Term Asset Fund (LTAF), which requires a notice period of between 90 and 180 days before an investment can be redeemed.

However, this has not fixed the sector’s problems, nor its reputation in the industry. According to data from FE Fundinfo, 10 out of 13 funds (including the soon-to-be-closed M&G Property Portfolio) in the IA Direct Property sector have shrunk in size over the last three years – by an average of 40%. Among these 10, falls in assets range from 7.8% for VT Redlands Property Portfolio, to an eye-watering 74% for M&G.

And, in order to combat liquidity risk, many funds in the sector hold significant cash weightings. This has come under fire from many investors, who argue that more of their cash should be put to work given the ongoing charges they pay.

Could the future of direct property funds be a hybrid model, and is LGIM paving the way for other existing PAIFs to restructure their portfolios?

Oliver Creasey, head of property research at Quilter Cheviot, says he is a “long-term fan, buyer and advocate” of hybrid property funds, holding positions in CT Property Growth & Income and TIME:Property Long Income & Growth.

The former, which is co-managed by Marcus Phayre-Mudge, Alban Lhonneur and George Gay, was launched as an OEIC in 2015, although Phayre-Mudge has been running the strategy since 2011. The latter, which is run by Roger Skeldon and Andrew Gill, was launched in September 2021.

“Both of these funds have approximately a 60:40 ratio to REITs,” Creasey explains. “So, in principle, [switching to a hybrid portfolio] is a good idea from our perspective – it is good to see a firm willing to innovate and look for a solution to the regulatory issue being faced, rather than throwing in the towel.”

But of course, a consideration for existing funds is whether those invested in them will welcome such a significant change to their investment proposition.

“The specifics are a little more complicated; we also have investments in LGIM’s property fund, and because of the diverse nature of our clients, not all will wish, or be able, to hold a hybrid fund – depending on how it looks once the idea is solidified,” Creasey explains. “We will have to wait and see exactly what changes are proposed before we can definitively say it’s a good idea, and whether it is suitable for a particular client or service. But it is a sensible move in principle.”

Darius McDermott, managing director of FundCalibre, also holds Legal & General UK Property and says “it appears to be a sensible option”.

“LGIM always have had a strong property team and offering. Shifting to a hybrid solution will ensure greater liquidity than historical norms, appealing to investors and regulators and potentially incentivising continued open-ended access to the asset class,” he reasons.

Meanwhile, Ben Yearsley, director of Fairview Investing, says he has been buying hybrid property funds for “six or seven years”.

“It gives you the best of both worlds – full property exposure alongside liquidity”.

AUM difference

However, the difference in assets under management between direct property funds and their hybrid counterparts is significant. Despite having a track record of more than 10 years, CT Property Growth & Income is £319m in size, while TIME:Property Long Income & Growth is just £15.8m. This is materially less AUM combined than the LGIM fund, alone.

Rob Morgan, chief analyst at Charles Stanley Direct, says the mandates are less popular among investors because they “potentially falls between two stools for some fund buyers”.

“It is neither purely physical property nor purely listed real estate equities – although the hybrid approach does offer an interesting middle ground, and a pragmatic way forward for LGIM,” he reasons.

“Generally buyers have taken the view to allocate to one or the other – direct property or through REITs or funds of REITs, or to mix and match according to allocation policies.”

If funds opt for the hybrid model but don’t stick to set REIT and direct property allocations, however, he warns this could “create some uncertainty around how performance and risk might vary over time”.

Ryan Hughes, investments director at AJ Bell concurs, explaining that cash and REIT weightings could fall if a fund experiences significant outflows and no set proportions are put in place.

“What L&G seem to be proposing is to ensure this liquidity buffer is significant in size so to reduce the risk of it drying up,” he says. “While this makes sense, it still isn’t addressing the underlying problem of holding illiquid assets in a daily traded fund.”

McDermott believes hybrid funds are less popular because they have a less established track record, while Creasey says: “I like to think it is an awareness issue, but L&G will have to spend some time educating existing and future investors as to what this idea means in practice and why it makes sense.”

Classification

The other issue that arises is based on sector classification. In 2018, the Investment Association divided its Property sector into two: IA UK Direct Property, where included funds must hold at least 60% in physical UK property over rolling five-year periods; and IA Property Other, which includes funds which invest in property company shares, or property funds and investment trusts.

And, as it stands, the IA’s Sector Committee considers 10 funds to be the minimum constituents in any one sector in order to make it viable.

A spokesperson for the IA says: “The IA seeks to review existing sector(s) from time to time. This is typically due to factors that suggest that something may have changed in the market, impacting on the number of funds that are like for like and could be usefully classified into a new sector to aid comparisons for end investors.

“Sometimes it is necessary to sub divide or close existing sectors, and on other occasions new sectors are created.”

The sector could continue to shrink by default, with a number of its constituents already falling below the 60% minimum direct property threshold. Aside from funds which are only available to institutional investors, this could leave just two retail-friendly PAIFs standing: Abrdn UK Real Estate and CT UK Commercial Property.

Charles Stanley’s Morgan says: “It feels like the property sectors should probably be merged at this juncture as a sector average comparison here is increasingly meaningless.”

FundCalibre’s McDermott adds that an “IA sector comprised of only two funds is not viable”.

“It is likely that Columbia Threadneedle and Abrdn will face challenges in maintaining their property funds in their current PAIF format. If they do, they will potentially encounter stricter liquidity requirements, making them less appealing to investors seeking daily liquidity.”

Columbia Threadneedle and Abrdn were approached for comment.

The future of PAIFs

Looking over the medium-to-long term, some fund buyers believe the longevity of traditional PAIFs is in jeopardy.

Quilter Cheviot’s Creasey says: “I feel that there is still a market for daily-dealt direct property, but it doesn’t suit all investors/circumstances. The lack of choice, plus the regulatory issues overhanging the sector do limit the appeal.

“I think the sector can survive, but whether it will or not is a different matter. It certainly requires regulatory certainty, but we are a long way away from a new daily-dealt fund being launched. Some investors will hope the remaining funds stick around, but few would blame them if they don’t.”

Both Fairview’s Yearsley and AJ Bell’s Hughes stopped using pure direct property funds some time ago.

“Why would you own them with the threat of suspension and only holding approximately 70% in physical property?” Yearsley questions. “Physical property and daily dealing don’t mix. One of those two variables has to change – it doesn’t look like the platforms will allow monthly dealing, therefore it has to be the funds changing.”

Hughes says there “has to be trade-off between illiquidity and access” and “investors have to accept this fact”.

“Given what has happened to the open-ended property space, it is clear investors prefer liquidity over access and therefore we have seen an increase in investor demand for listed property assets,” he says.

“This trend seems to have momentum, with only a few lone voices fighting against it. In our investment team, we stopped using illiquid, open-ended property in 2019 as we saw the risk of suspension as too great and moved solely to investing in listed property securities.

“With the open-ended space almost shrinking to nothing, I suspect the vast majority of investors either have or will follow suit.”

That being said, AREF – The Association of Real Estate Funds – believes the headwinds facing the sector have been overstated.

During an online presentation at the end of last year, its managing director Paul Richards acknowledged previous difficulties with funds being forced to shutter, but argued that these were rare occurrences relative to the lifecycle of open-ended property funds. He added that PAIFs offer other benefits, including low correlation with other asset classes and differentiated income streams.

On hybrid funds, Richards says: “ It’s a fascinating move that will provide those investors who want daily liquidity with continued access to the underlying real estate assets. The benefit of the open-ended property funds holding direct real estate, be they daily-, monthly- or quarterly-traded, is that they provide lower volatility than listed shares and a level of diversification against the wider listed equity market. This is especially useful if you’re a large institution with little interest in daily liquidity.

“But if you need daily liquidity – perhaps because you’re a DC pension scheme whose platform can’t or won’t accommodate monthly or quarterly dealing, the daily-traded, open-ended funds remain. They provide daily liquidity without the significant volatility of REITs.”

Morgan concurs that REIT exposure is not necessarily the ultimate fix to the property fund conundrum, reasoning that he is “still wary of having a meaningful proportion of illiquid assets making up a daily dealing fund”.

“REITs themselves aren’t necessarily highly liquid, especially in times of market stress,” he points out.

However, McDermott expects to see more hybrid funds come to market, primarily from firms with existing property teams and “proven expertise”.

Yearsley adds: “I think hybrid property funds are great. I don’t know why other firms don’t launch them.”

Creasey, however, says it is “too early to say” whether this will become a reality. “Options have existed for a while and haven’t captured investor imaginations yet. The structure is very interesting to us, but it is slightly more complex and investor education will be key.”

This article was written for our sister title Portfolio Adviser

The economist and author tells our sister title Portfolio Adviser there is a “tug of war” debate as to whether rates will return to near-zero levels as inflation falls, then revert to a ‘new normal’ of 2% or lower; or whether the past two decades of ultra-low interest rates were an anomaly, and that they are set to return to a more normalised range of 3-5%.

Depending on which scenario comes to the fore, she says there will be significant ramifications on which asset classes will outperform, and which will struggle, over the medium-to-long term.

“Anything where the opportunity to generate returns is based on a low rate is going to suffer. So, anything that relies on leverage or on taking outsized bets – I believe venture capital falls into this space, for example,” she says. “This is why I don’t think the Targeted Absolute Return sector is winning right now, either.

“Of course, there is a debate as to whether we will return to a low rate environment, in which case these opportunities could become interesting again. But given what happened to markets in 2022, 2023 was a case of going back to basics and asking: ‘in a higher cost-of-capital environment, where will the genuine returns come from?’”

Over the last three full years, equity and corporate bond market returns have varied widely. In 2021, the MSCI All-Country World index achieved a total return of 19.6% while the Bloomberg Global Aggregate Corporate Bond index fell 2%. Then in 2022, global equities suffered with the MSCI ACWI falling by more than 8%, while global corporates also lost more than 6%. Both asset classes achieved positive returns last year at 15.3% and 5.5% respectively, according to data from FE Fundinfo.

These returns coincide with varying moves from developed market central banks in a bid to curb rising inflation. When central banks embarked on interest rate rises at the end of 2021, bonds suffered while economic uncertainty weighed on equities. Rate hikes continued throughout the course of 2023, with inflation beginning to fall by varying degrees across the US, the UK and Europe.

“In 2023 there was a lot of discussion about value investing returning to the fore,” Baroness Moyo says. “If we consider the businesses which can survive over the long term and generate real returns above the cost of capital, these types of businesses certainly do look interesting. Which is why what happened in 2023 was odd, because the performance of growth stocks such as the Magnificent Seven was an anomaly in terms of the mood music of markets, given the interest rate moves we had seen.

“In short, it has been too easy to make good returns in bog standard, traditional multi-asset portfolios. You didn’t have to go into long/short portfolios, or venture capital, or anything that required a lot of leverage to make returns. And in fact, it is those areas which have now become higher risk. So, for now, I would argue that it is still very difficult to make the case for people to allocate capital to absolute return strategies.”

See also: Morningstar: Are basic allocation strategies still relevant?

The economist says that, while investors started 2023 “excited about credit”, given interest rate expectations, they are now beginning to hold off and question longer-term themes, given continued economic uncertainty.

AI and decarbonisation

“I would argue that there are two huge key themes. One is AI; hence the Magnificent Seven breaking out of that value anomaly last year. The second one is decarbonisation,” Baroness Moyo – who is also co-principle at the Versaca Investments family office – says.

“The last time we had a catalytic move in the economy on a structural basis was the 1980s, when we saw tech investment opportunities. This is the next one.”

These two themes spell a “real fundamental shift” in how economies will work in the future and therefore which assets will perform well, the economist says, although she adds that the cost of capital “obviously matters” in terms of how people will play these markets.

In addition to historically higher rates, Baroness Moyo says geopolitics have become more volatile – at a time when markets are pricing in interest rate cuts.

“I don’t think anyone over the last year would have accounted for two wars, the announcement of 11 countries joining Brics, swing states – real issues that could now be re-inflationary,” she warns.

“US inflation still stands at 3.1%. Germany is in a recession and Europe is weak, which could signal that rate cuts could be on the docket.

“Geopolitics could be incredibly disruptive, and could mean we live a ‘higher for longer’ environment and that is set to continue.”

Finding dislocations

Alongside moving out of leveraged plays, this uncertain backdrop has also led Baroness Moyo to play equities more “opportunistically”, holding out for market dislocations in favoured sectors such as healthcare, or more attractively-valued companies set to benefit from AI.

“We are mostly looking at AI on a ‘wait-and-see’ basis for the reasons that I mentioned. But if we start to see real productivity gains and genuine possibility for disruption from AI, I think it will be an opportunity.

“What does this mean for us? It means a skew towards taking money out of equities and putting it into cash or bonds, and waiting for opportunities in these much more structured bets such as AI.

“If it is true that, over the next 20 to 30 years there will be a fundamental shift in how the world operates, we want to be a part of that. So, the best thing to do is to dip in and take some money out of markets where we could be losing and put it into bonds, which are earning us 5.5-6%, until there is more clarity around how best to play the AI space.”

That being said, Baroness Moyo has “taken a nibble” at some less widely-held stocks she believes are attractively valued such as US healthcare provider HCA and cloud-based software company Salesforce.

Not-so-magnificent Seven?

When it comes to the Magnificent Seven stocks – many of which have become synonymous with investing in AI such as Nvidia, Amazon and Alphabet – Baroness Moyo is less tempted and says valuations are “too rich”.

“I understand the whole euphoria; it’s the New Year, let’s all get excited. But the market has sold off a fair amount already, coming into the year.

“But when it comes to the Magnificent Seven, which are trading on high price-to-earnings multiples… We had a bad 2021, a mixed 2022 with a big skew to certain stocks. In 2023, my sense was that people were waiting and seeing. And now, I think people are waiting for that first rate cut, then they are going to bank as much of that return as possible.

“So if anything, I’m worried that markets are going to sell off. Not initially, but I think institutional investors could be waiting for a rate cut and a market rally, at which point they will bank their gains tactically.”

The other risk with the Magnificent Seven stocks, says Baroness Moyo, is that they account for a very significant proportion of the S&P 500. According to data from Yahoo Finance, this handful of companies accounts for 29% of the US index’s entire market cap.

“If I look at the Magnificent Seven versus the 493 remaining stocks in the index, and I had to take a bet on either a bigger rally among the Magnificent Seven, or a revenue catch-up from the 493 others, I am going to bet on the catch-up,” she reasons.

“Do I believe that tech is the future? Absolutely. But we are talking about a numbers game here. I am looking at multiples and margins, the ability to grow top-line revenue and the ability to cut costs.

“On that basis, I think it will be harder for those very efficient larger companies, which achieved enormous gains in 2023, to continue that growth. I think a lot of value has been squeezed out of the Magnificent Seven, and a lot of that value is now dependent on how they execute on AI.”

Value in energy

In contrast, Baroness Moyo says the energy sector offers attractive valuations. “Why? Because we’re consuming 100 million barrels of oil every day across 8 billion people. People need energy to live – whether that is from fossil fuels or from renewables. That is an area where I think there have been relatively bad returns, but there is real opportunity for upside.

“For me, value investing is about a compelling sector-based narrative that is based off of basic needs, such as food, energy and transportation. But these companies have to be well-run. You have to be able to look at the margins, the fundamental demand and what that might mean for long-term opportunities, in order to generate risk-adjusted returns above the cost of capital.”

For the economist, this could mean investing in companies which provide fossil fuels and are looking to embark on the transition to net zero, as well as those leading the charge on reducing our dependence on carbon.

See also: Canada Life’s Sriharan: The rules of engagement on asset allocation have changed

Zambia-born Moyo says: “When you have been raised in an environment – like I have – where electricity and water is not automatic, you have a very different understanding of how difficult it is to deliver energy and deliver water.

“In the west, there are a lot of people who have good intentions for us to move and transition into this new equilibrium, which is renewables-based. That’s fantastic. I don’t know anybody who is against that.

“However, we have to be sensible about what the costs of that journey are and how easy it is to execute. It’s 2024 and there are many countries around the world which cannot create energy on a sustainable basis. And I’m not just talking about desperately poor countries – this includes middle-income countries like South Africa. Even California has suffered from energy disruption.

“This, to me, is precisely the dislocation that presents investment opportunities. The vast scale of our energy requirements, the need to transition, and the requirement to find the best companies at actually providing this.”

Has Japan turned a corner?

On a regional, macroeconomic basis, Baroness Moyo is positive on the US and Japan. When asked whether Japan has become a consensus trade, given its recent stockmarket rally, Baroness Moyo says there are two key reasons the market has performed so well. “One is technology and the other is energy – the two big long-term trends driving markets. These are massive pivot points for the world, and I think people see Japan as very much at the coalface of that.”

But people have been predicting a “new dawn” for Japan for decades – since its economy slumped throughout the nineties. Is the recent recovery the real deal? The economist does indeed believe the country has “turned a corner”.

“It’s extremely difficult to run an economy, to get a slow economy moving, and to get businesses and companies to work efficiently. There is a whole potential system of errors – a lot of things have to go right, and we have seen in the past how quickly things can fall apart. Germany was a huge economy doing well, and look how quickly it has come off the rails,” she explains.

“Japan has a lot of things going right for it. It has strong levels of high education, it has a business sector which is sharp and knows how to innovate. It is difficult for a country to put these things in place.

“We have seen it in the UK – I often talk about how, 15 years ago, business was a big piece of the story. Business accounted for a large part of the UK economy; everyone was talking about the banks, Rolls Royce, Marks & Spencer. Today, that is less the case.”

Home market

Indeed, while the Topix has gained 9.2% over the last six months alone, according to FE Fundinfo data, the FTSE 100 has achieved less than one quarter of these gains over the same time frame, at just 1.3%. It has also achieved less than half of the gains of the MSCI All-Country World index over the last five and 10 years. Does the UK market present a value opportunity?

“I’m afraid it will still be a case of ‘wait and see’ for the UK. There is a lot of hope that this is the home of industrial revolution; that we can get back to business and back to clarity. But the business and markets have become so intertwined with politics that there is risk,” Baroness Moyo says.

See also: Facing the inflation dilemma head on

“It is at the point with politics where business has not been able to work without a political overhang creating costs from a regulatory perspective, and from a risk mitigation attitude when it comes to investing.

“In the US, if I talk about AI or the energy transition, the first question people will ask me is how much money they could make if they invest $1 – what return would this generate? When I have the same conversation in Europe, the first question is how to mitigate any risks coming from those themes.

“Our only way out of this is to find some kind of balance between these two attitudes. I’m worried that a lot of conversation in the UK is still very top down and government led, where people would rather kill off investing in certain areas, rather than use innovation to solve any issues.”

Emerging markets

Baroness Moyo is also reticent to invest in emerging market equities, arguing there are other areas where investors can generate “considerable returns, above the cost of capital, without the inherent risk”.

“I understand the arguments on paper. The macroeconomic arguments are very compelling. But as a practical matter, life is too short,” she says. “It sounds flippant, but it’s fundamentally true. Investors only have a certain number of years to make returns. That doesn’t mean they can’t ultimately achieve gains and compound those returns. But why take the risk by putting your capital in a market with slowing growth geopolitical risks and FX problems? It’s very hard.

“In my case, I only have 20 years to compound any returns. Why would I waste my time trying to work my money in an uncertain environment? Yes there could be some outside bets but I am willing to leave that money on the table.”

See also: Top five investment themes to look out for in India in 2024

She cites India as an example which is popular among investors. According to FE Fundinfo, the MSCI India index has returned 26.3% over the last year – more than double that of the MSCI ACWI.

“Lots of people say they are going to make billions by investing in India. Good luck to you, but I am willing to reduce my basis-point returns and not have to deal with the risk,” she reasons.

“Would I ever say India is never going to make it? No, it’s not my place to say that. But what I will say is it is extremely difficult to generate predictable returns in that kind of environment. There is a lot of red tape; it is definitely skewed towards locals winning over the foreign partner. It doesn’t have a great track record.

“People have to understand it’s not free money; there are other places you can invest and generate returns with relatively little risk.”

This article was written for our sister title Portfolio Adviser

In the annual rebalance, which highlights the top 10% of UK retail-facing managers over the course of their careers, managers such as Goldman Sachs’ Jeroen Brand, Pimco’s Daniel Ivascyn, Wellington’s Evan Ouellette and Axa IM’s Nicolas Trindade also received the accolade for the first time.

Alongside the 18 new entrants, four managers returned to the list having been featured once before: Tim Gregory, who runs the Vermeer Global fund; David Absolon, who heads up the Handelsbanken Defensive Multi Asset fund; Raymond Ma of Fidelity China Consumer; and King Fuei Lee, who manages the Schroder ISF Asian Equity Yield fund.

From a group perspective, Fidelity boasts the largest number of FE Alpha Managers at 10, followed by JP Morgan at nine. Baillie Gifford, Schroders and Wellington Management Funds all have seven FE Alpha Managers, while Janus Henderson has six. Royal London Asset Management, Premier Miton and Jupiter each have five FE Alpha Managers.

Charles Younes, deputy chief investment officer at FE Investments, said: “The Alpha Manager Rating is our most consistent rating at FE Fundinfo, as it considers a manager’s track record across his or her entire investment career. That rating is therefore immune to short-term investment cycle and market rotations.

“Therefore the list of Alpha-rated managers tends to be unchanged year on year, although it is always great to find rising talents reaching this distinction. And the 2024 vintage is no different to previous years”.

This article was written for our sister title Portfolio Adviser

Instead, key industry figures are calling on institutional investors to help “shoulder the burden” of boosting the performance of lacklustre UK equities, and believe the simplest solution to encouraging more retail money into the home market is to abolish stamp duty and increase the tax-free threshold of the original ISA.

Days before Chancellor Jeremy Hunt’s Autumn Statement in November last year, it was widely expected he would announce the launch of a British ISA, which would allow investors to increase their £20,000 tax-free limit by £5,000 in order to invest in UK stocks, in a bid to bolster the ailing home market.

See also: Pridham Report: ‘Bruising’ 2023 sees record outflows for UK fund industry

This was notably omitted from the statement, however, with Chancellor Hunt instead pledging to “simplify the [ISA] scheme” and “widen the scope of investments that can be included in ISAs”. Confirmed changes from the 6 April this year include permitting multiple subscriptions to ISAs of the same type each year; and enabling savers to hold LTAFs and open-ended property funds with extended notice periods within Innovative Finance ISAs. ISA, Lifetime ISA and Junior ISA annual subscription limits remained unchanged at £20,000, £9,000 and £4,000 respectively.

The reason British ISAs were left out of the Autumn statement became apparent at the end of last month, however. According to a report from The Telegraph, Prime Minister Rishi Sunak has pushing back against HM Treasury over the scheme, which allegedly would have been rolled out from the start of the 2025/26 tax year – beyond the date of the upcoming general election. Concerns cited by the No.10 officials, according to the report, include dictating where investors should put their money, and a lack of appetite for the launch of a new ISA product.

Now, ahead of the Spring Budget on 6 March, platform providers and senior investment professionals are calling for the British ISA to stay firmly off the cards, with many warning they could have negative implications for investors.

Tom Selby, director of public policy at AJ Bell, calls the concept of a British ISA – sometimes referred to as a GB ISA or BRISA – “a bad idea”, although says it is not exactly clear yet what the scheme would propose.

“Some have suggested this could mean an extra ISA allowance to invest in UK companies and funds, which would increase complexity,” he explains. “Others have argued ISAs should only be allowed to invest in UK companies and funds, significantly reducing the ability for investors to diversify globally. Both would be retrograde steps and should be resisted by the government.”

Susannah Streeter, head of money and markets at Hargreaves Lansdown, says: “It’s not surprising there appears to be scepticism about the plan right at the heart of government. The economy is clearly in need of an injection of investment to help drag economic growth out of a stupor, but mooted plans for a British ISA to help direct investors’ money into UK-listed companies adds unnecessary complexity, could fail to achieve its aims, and could have a negative impact on UK investors.”

Concentration risk

One of the key criticisms of a proposed British ISA is the concentration risk it could expose investors to – made worse by the fact the UK stock market has been so volatile over recent years. According to data from FE Fundinfo, the MSCI United Kingdom index has a maximum drawdown – which measures the most money an investor could have lost had they bought and sold at the worst possible times – of 31.6% over the last five years. Its MSCI World counterpart has a maximum drawdown of 24.6% over the same time frame.

Rob Morgan, chief analyst at Charles Stanley Direct, says: “This is the big issue for me; there has been precious little said in this debate about what is right for the individual.

“A British ISA, if directed at single stocks, corrals private investors into taking on more stock-specific risk and concentrating their portfolios. Most investors are not in a position to navigate the complexities and risks of buying individual shares and are better served by using collective funds and spreading their investment.

“In addition, many investors already have significant exposure to the UK and further investment in this area is neither necessary nor desirable from the perspective of proper diversification.”

Andrew Prosser, head of investments at InvestEngine, agrees, adding that for an ISA to work best, investors should hold a globally diversified portfolio.

“If an equity investor managed to fill their regular ISA by investing in a global portfolio, and then also filled up their British ISA, the resulting portfolio would have an allocation of over 20% to UK equities. This is a significant deviation from the UK’s weight in the global equity market, which currently stands at just over 3%,” he explains.

“Investors may also be tempted to fill their British ISA before contributing to their regular ISA, which would result in even more concentrated portfolios. This ISA is encouraging savers to take large active positions within their portfolio for protectionist reasons. Home bias is already an issue for British investors, and this would exacerbate the issue.”

Indeed, Streeter concurs that UK investors are already firm backers of the London Stock Exchange, with 1 million of Hargreaves Lansdown’s 1.8 million clients currently invested in UK equities. This accounted for 80% of the platform’s trades in the last year, with 70% of investors holding at least part of their position in a company for more than 12 months.

Sheridan Admans, head of fund selection at Tillit, says: “While the BRISA poses an interesting possibility for encouraging investment in UK companies by UK savers, without more detail it seems like a great deal of expectation is being put on the shoulders of retail investors to come to the rescue at a time they are being squeezed by more immediate demands.”

Will it work?

Admans adds that, according to HM Revenue & Customs data from June 2023, stocks and shares (ex-cash) ISA subscriptions for 2021-2022 totalled approximately £34.2bn.

Given the UK listed market’s mid-2023 market cap of approximately £3.6trn, he says “the BRISA alone may not be the immediate solution to this pressing issue”.

And Jason Hollands, managing director of corporate affairs at Evelyn Partners, warns that UK savers could simply use such an allowance to invest less in UK equities in their core ISA allowance “to compensate for the restrictive nature of a British ISA”.

“A new British ISA would also likely only be utilised by those already maximising their core £20,000 ISA allowance,” he says.

“This is relatively modest number of people in the scheme of things, which also includes those using the £20,000 allowance solely for cash savings, not investments.”

Streeter agrees with Hollands that investors could find a way around compensating for the UK allocation requirements, adding: “Those who already max out their £20,000 ISA allowance could simply hive off all their existing UK holdings to the British ISA, and use the extra wiggle room to invest more overseas in their usual ISA.”

And even then, research from InvestEngine’s Prosser found that fewer than 15% of investors reach the maximum £20,000 capacity in their ISAs, in any case.

The other issue with relying on UK savers to bolster the health of the UK stock market is the FTSE 100’s global nature, with approximately 75% of its revenue being generating from overseas.

Paul Derrien, investment director at Canaccord Genuity Wealth Management, says this is a “big issue”, pointing out there is “significant amounts of overseas earnings in the FTSE 250 too”.

“So, who is this policy benefiting? Maybe there needs to be a restriction on how UK-centric the business actually is, though how this would be applied in practice sounds too onerous.”

AJ Bell’s Selby also says ISA investments into UK-based companies “will not necessarily result in a substantial boost” to UK firms, given FTSE 100 companies are “generally international businesses”.

Creating complexity

There will be creases to iron out when it comes to the design and implementation of the British ISA – if it ever comes to fruition. Details on the product so far are scant, although several commentators fail to see a fool-proof way for the product to improve UK stock market performance while simultaneously benefiting investors.

“What constitutes a UK investment? UK-listed shares or a subset? Would investment trusts or other collective vehicles be included?” Charles Stanley’s Morgan asks. “Would this be a separate extra allowance or part of an expanded ISA wrapper? The former would create yet another product and the latter would represent a challenge for monitoring and reporting.

“Any segregated allocation would rise and fall at a different rate to the rest of the investments in an account, and selling and buying activity would further complicate matters.”

Not only could providers come up against challenges, for the investor themselves, there is the additional argument that another ISA will only increase complexity – contrary to Chancellor Hunt’s pledge to simplify the initiative. To date there are five different types of Individual Savings Accounts: Cash ISAs, Stocks and Shares ISAs, Lifetime ISAs, Junior ISAs and Innovative Finance ISAs.

“The British ISA complicates the already convoluted world of tax wrappers when really the government should simplify the regime,” says InvestEngine’s Prosser.

“Instead of progressing with a British ISA, the government should streamline the ISA wrapper by only having one type of ISA to cover savings and shares, with a single annual limit and education cues about what investors can use their ISA for.”

Morgan agrees that a British ISA “is at odds with calls for ISA simplification”.

“Over the years a once-simple ISA regime has morphed into a many-headed beast with such variations as Help to Buy, Innovative Finance and Lifetime ISA popping up, potentially exacerbating lack of consumer understanding.”

James Yardley, senior research analyst at Chelsea Financial Services, says: “It sounds rather complicated and highlights a potential risk of this strategy by the government.

“The great success of ISAs has come through their simplicity. They’re easy to understand and implement, but as soon as you add in complexity people will switch off. In theory this may be a good strategy, but we will need to see more details first.”

The benefits

Not every aspect of the British ISA has been met with criticism. Yardley reasons that it could have “a much-needed positive impact on investor sentiment” towards the UK stock market.

“It will encourage people to invest in the UK,” he says. “A lot of people who should be investing don’t, which is a crying shame because it causes them to have much worse financial outcomes throughout their lives. ISAs are a great vehicle for people looking to start their investment journeys with freedom from capital gains and income tax.

“We need a stronger UK stock market that allows British companies to access capital markets and grow more efficiently. What has happened to the UK market has been a self-inflicted calamity.”

According to data from Statista, the number of companies trading on the London Stock exchange between January 2015 and July 2023 has fallen from 2,429 to 1,900 – a 21.8% decline. Meanwhile, a survey from the Quoted Companies Alliance published at the end of last year found one in four listed UK small- and mid-cap businesses saw no benefit in being publicly quoted.

Canaccord’s Derrien also believes the British ISA could encourage investment back into UK firms, which could therefore “potentially stem the tide of companies not being listed in the UK”.

Mike Coop, chief investment officer at Morningstar Investment Management EMEA, says UK equities offer “a long history of innovation and commercial enterprise, as well as safeguards for investors”, despite negative sentiment. He therefore says a tax-effective way to gain access to British companies “would be welcome”.

“The research we use when we’re building portfolios for advised investors indicates better value on offer for UK listed companies at current prices than many other markets, so there is a return potential and, for those seeking income, the UK does offer currently a higher level of yield than many other markets,” he points out.

Dan Moczulksi, UK managing director at eToro, argues that if the British ISA is built in the correct way, retail investors “should not have to take any additional risk”.

“They should still be able to invest their core ISA allowance in whatever way they see fit and then have the choice of using an additive allowance for UK-listed companies,” he says.

“Any new vehicle which incentivises more investment in UK-listed companies obviously stands to benefit these companies. It’s a virtuous cycle. More investment in these firms means more capital for them to deploy, helping them to grow. It also means share prices move higher, attracting further investment for retail investors seeking good returns.

“This in turn makes the UK a more attractive place to list as a business, as firms feel confident that their share price will improve and they will attract a lot of investment. Big, well-known companies listing in the UK would then attract more attention from retail investors, and the cycle goes on.”

Remember PEPs?

While there is widespread agreement that something must be done to improve sentiment towards buying into UK stocks, some commentators says the scheme is reminiscent of Personal Equity Plans (PEPs).

Launched by the UK Government in 1992, the initiative was designed to encourage investment from UK savers into the home market via various tax incentives. However, the scheme was scrapped in 1999 and replaced with the ISA.

Charles Stanley’s Morgan says: “Rewinding back into the midst of time, this was the logic behind merging the Single Company PEP allowance with the General PEP to ultimately create the ISA in the first place.

“Investors were experiencing a wide range of outcomes with Single Company PEP, and it was decided that freedom of choice to encompass collective vehicles was preferable.”

Canaccord’s Derrien adds that, over time, the restrictions on buying UK businesses were removed as the product transitioned into the ISAs we have today.

Fixing the conundrum of the UK stock market

If the UK stock market is in dire need of revival, but a British ISA is not the tool to do so, is there anything else the government can do to breathe life back into our listed companies?

“Yes. A lot,” says Chelsea Financial Services’ Yardley. “They can eliminate stamp duty; reform the horrendous cost disclosure rules that disadvantage the investment trust sector; and empower a new generation of investors by enhancing financial education and encouraging people to move their Junior ISA investments out of cash and into the stock market.

“They can also incentivise pension funds to invest in UK stocks – perhaps starting with the pension funds of MPs.”

Other investors agree that targeting retail investors is not the right course of action, with Morgan concurring that while UK investors have a decent exposure to their home market, “pension funds have little”.

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Tillit’s Admans says: “Perhaps it’s time for the government to play a more proactive role in encouraging institutional participation in the UK stock market, directing more attention towards stimulating overall economic growth, and considering measures to ease interest rates and alleviate the pressure on living costs.

“Although the UK market presents itself as cheap, there’s a need for a more immediate and strategic catalyst to attract both local and international institutional investors to bump up valuations, rather than placing this burden solely on UK savers, especially amid a cost of living crisis and at a point in time where consumers are faced with higher mortgage rates. The cost of living alone saw £6bn less contributed to cash ISAs in the last financial year compared to the prior year.”

On the education front, InvestEngine’s Prosser says: “We would like to see more provisions for better financial education. Boosting it from an earlier age would enable more people to understand the benefits of long-term investing and move us away from being a nation where saving in cash is the default option.

“As part of this, consideration could be given to renaming ISAs to ‘Tax Free Accounts’ to make clear the main benefits of using them in order to increase engagement.”

Morgan says it is “no wonder” that private investors feel “increasingly put upon”, given recent significant cuts to capital gains and dividend allowances.

“Perhaps a more generous CGT rate or allowance for new holdings in UK stocks could be implemented, if held for a certain period,” he reasons. “The focus on capital gains would also naturally attract capital to more growth-orientated and smaller companies than on dividend-paying mature companies, but by simultaneously increasing the dividend allowance there could be a broader effect if desired.”

Evelyn Partners’’ Hollands says a British ISA would have to be accompanied by a wider package of reforms if it is to “move the dial” on UK stocks, which should include removing stamp duty on UK share purchases or “giving favourable tax treatment to UK shares in respect of inheritance tax or capital gains tax”.

eToro’s Moczulksi agrees that abolishing stamp duty when investing in UK-listed companies through the BRISA would “undoubtedly be an effective incentive”.

“Government contributions could also be the answer, adopting the same approach as a LISA, with the government contributing an additional 25% a year up to £1,000.”

Overall, however, the message from commentators seems to be clear: an increase in the original ISA’s tax-free threshold could solve a multitude of the UK stock market’s ailments. The allowance was last lifted almost seven years ago – to £20,000 in April 2017, from £15,000 just three years previously, and from £11,880 before that.

AJ Bell’s Selby says: “Given most investors have a natural bias towards UK companies and funds anyway, the most straightforward answer would be to simply to increase the ISA allowance.”

Hargreaves Lansdown’s Streeter adds: “Simply lifting the ISA allowance, without creating a new product, would result in a boost to investment in UK equities anyway. It would also still offer the potential for diversification, helping bolster retail investors’ resilience.

“Not putting all your eggs in one basket is one of the golden rules of investing, and it’s crucial that government policy continues to support that.’’

HM Treasury’s press office has been contacted for comment.

This article was written for our sister title Portfolio Adviser