Ian Cowie on how the mini-budget could affect investment companies.
For good or ill, few full-blown budgets make as much of an immediate impression on investors as Chancellor Kwasi Kwarteng’s mini-budget. Pre-announced tax cuts - including the reversal of planned increases in National Insurance Contributions (NICs) - and a maximum cap on energy prices were welcomed by some people and businesses. But the proposed abolition of the 45% top tier of income tax proved so unpopular it had to be dropped. Bond and foreign exchange markets also reacted negatively after Kwarteng had finished his speech and British government gilt-edged stock prices moved sharply lower.
Banks and building societies scrapped fixed-rate mortgage offers as fears grew that interest rates might hit 6 per cent next year and some pension funds reacted by selling gilts. That added to the downward pressure on bond prices before the Bank of England’s £65 billion emergency intervention to support the pound brought a measure of calm to markets.
It is too early to say how successful the Bank and the Chancellor will be over the medium to long-term. In the short-term, the Bank’s bond-buying programme is scheduled to end on October 14 and the Chancellor is due to set out a “medium-term fiscal plan” later this month but he does not intend to present a full budget until next spring.
Here and now, stock market shocks and sterling’s weakness served to remind this long-term shareholder about some of the fundamental strengths of investment companies. First and foremost, they can diminish the risk inherent in investment by diversification or spreading our money over different companies, countries and currencies.
The latter point is particularly topical with talk in the Square Mile about a possibility that the pound might reach parity with the dollar. Whether or not that happens, it is a matter of historical fact that sterling has lost more than half its value since 1967, when Prime Minister Harold Wilson cut the exchange rate to $2.40 and promised this did not mean devaluation of “the pound in your pocket”.
Sterling still bought $2.05 when Northern Rock crumbled in 2007 and nearly $1.50 immediately before the Brexit vote in 2016. At the time of writing, it fetches just under $1.12 - or about what it did before Chancellor Kwarteng began his mini-budget.
Setting aside fluctuations in foreign exchange rates, investment companies make it convenient and cost-effective for individual shareholders to gain exposure to economies overseas. This was one of the original aims of the very first investment company, set up in 1868 and still trading on the London Stock Exchange as F&C Investment Trust (stock market ticker: FCIT), which aimed “to provide the investor of moderate means the same advantage as the large capitalist”.
Now, as then, it is not practical for most investors to seek direct exposure to markets that trade while we are asleep, which talk in foreign languages and have different fiscal systems. In addition to FCIT, there are 15 other shares in the Association of Investment Companies (AIC) ‘Global’ sector and many others that enable shareholders to spread risk and seek returns overseas.
Investment companies also make it convenient and cost-effective to share the expense of professional fund management and gain access to specialist sectors where we may know next to nothing. Two of my most long-held and valuable investment companies, Polar Capital Technology (PCT) and Worldwide Healthcare (WWH), do both on a global scale.
Closer to home, there are commercial activities which are either so large - or so small - that it would be impractical for most individual investors to gain direct exposure to these sectors. But investment companies in the AIC’s ‘Infrastructure’ sector enable shareholders of all sizes to participate in multi-million pound projects, such as laying submarine cables for the worldwide web. Meanwhile, no fewer than eight venture capital trust (VCT) sectors enable shareholders to seek returns from new and/or small firms focussed on biotechnology, environmental, healthcare, media and technology.
Increased investment in infrastructure is vital to produce the economic growth that Chancellor Kwarteng has identified as essential to Britain’s future. Investment companies’ closed-end structure gives them access to ‘permanent capital’ that is ideal for large-scale long-term projects, such as infrastructure.
At the other end of the corporate scale, smaller businesses backed by VCT investment companies sometimes have the most scope for growth. So Chancellor Kwarteng’s removal of the ‘sunset clause’, that would have curtailed VCT investors’ 30% up-front income tax relief from April, 2025, was welcome.
More widely, the mini-budget also scrapped plans for an extra 1.5 percentage points of income tax on shareholders’ dividends and reversed a six percentage point increase in corporation tax. Both initiatives are likely to be welcomed by investors and businesses, seeking growth and income or a mixture of both.
This was a mini-budget with maximum impact, whose reverberations may be felt for years to come. Whatever the future holds, investment companies can help us cope with political surprises and stock market shocks by minimising risk and maximising our exposure to economic growth, wherever it can be found.
