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Individual investors are increasingly finding that they should use open-end collective investment schemes such as mutual funds to invest in stock markets, rather than investing directly in the underlying securities.
The rise in popularity of passive funds has exacerbated herd mentality, which has led to a major collapse in direct retail participation in UK stock markets.
Since 1963, UK retail investor participation in UK stock markets has fallen from 54 per cent to 10.8 per cent in 2022, according to ONS figures. While part of the reason has likely been that US markets have significantly outperformed the UK over the past decades – and this cannot be ignored – this does not tell the whole story.
I believe that successive British governments bear a great deal of responsibility for what happened. Following pressure from large institutional investors, both in the UK and the EU, they have used tax policy to encourage individual investors to put money into collective investment schemes and exit direct investment.
However, these investors have little say in the management of the companies in their funds, unlike direct shareholders. This is a worrying phenomenon when it comes to the relationship between investors, investors and business management in the UK.
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Investors are attracted to the tax incentives of collective investment schemes, such as no VAT payable on the annual management fee; the ability to reduce the amount of stamp duty by 0.5 per cent by the proportion of the fund not invested in UK shares; And for eligible groups (most) freedom from the complex annual obligation to report gains and pay capital gains tax (CGT) regardless of profit or loss. The issue of CGT has become increasingly unfair over the past few years, with the annual relief repeatedly reduced and set to be halved again.
Additionally, most investors who follow this fund-based consensus do so because of the ease of purchasing a pre-packaged investment product from a regulated product manufacturer. However, governments have failed to understand that direct ownership of companies is fundamental to capitalism and that individual investors play an important role in the health of their domestic markets and the accountability of companies.
As the retail investor base gradually shifts to include more Generation Z and Millennials, this is likely to become even more important. As intellectually and socially diverse generations, they constitute a powerful force; They believe in taking action and holding themselves and others accountable. They also expect the companies they interact with as shareholders, consumers and employees to be equally proactive.
On the other side of the coin, most equity investors through funds have little idea which companies they own, let alone the value of their stake in each, and have no role to play.
A further blow to the retail investor community came with government legislation on the rights of nominee holders when the Crest System, an electronic settlement system, was implemented in 1996. This disenfranchised them and created a three-tier model where nominee holders were essentially a third tier. Citizens were deprived of many of their rights, such as automatically receiving reports and accounts, notification of any material event, the right to vote on their shares, and the right of pre-emption, which entitles them to purchase new shares before other investors.
All this means a breakdown in the important relationship between individual shareholders and PLC in the UK.
It is disappointing that no one in government has given much thought to the devastating impact on retail investor behavior of using tax policy to encourage institutional fund investment over direct investment. It has failed to protect many rights that individual investors have lost to institutional investors.
The government must take a comprehensive look at its policies related to investment in the retail sector. Reigniting it will benefit UK business and the UK economy as a whole.
Paul Killik is the founder and chief executive officer of Killik & Co
