This weekend I had the joy of trying to explain to my adult children what the difference was between all the different ISAs they could invest what little money they had. This conversation was prompted by their confusion about why a new ISA had been introduced in last week’s Budget.

They’d only just got their head around the difference between a Cash ISA and a Stocks and Shares ISA and then I had introduced the scintillating Innovative ISA (remember that?) and the Lifetime ISA which went down a storm as it involves free government money.

This time it was the turn of the British or UK ISA to confuse them. As you’ll be aware, the most impressive piece of lobbying in recent times has resulted in a new £5,000 tax-free allowance for investors in British stocks. The letter from asset managers requesting the new allowance was only a few weeks old and seems to have hit the bullseye. (Here’s hoping my letter to the Treasury requesting that we properly fund our armed forces up to 3% of GDP also receives the same prompt attention!)

Anaemic FTSE

Overall, I’m not an enthusiast for this new ISA, but it is worth dwelling on the practicalities of how this one is going to work.

The economics commentator Sam Bowman has said that the UK’s ISA can claim to be the most powerful savings vehicle in the world. His main concern is that ‘if the government had done this ten years ago, British savers would be much poorer today. A lot of people probably wouldn’t have bothered saving at all, if the only tax-free option was a real-terms loss in the anaemic FTSE 100.

‘The lesson is that being concentrated in a single country could have been fantastic, or it could have been – in this case, if that country was Britain – catastrophic.’

He also worried that the UK ISA wouldn’t solve any of the problems it’s aimed at: ‘The assumption here is that there are loads of UK companies that would grow rapidly if they only had more access to money. But if that’s wrong, and returns are low for any other reason, then forcing more money in will do the exact opposite of what is hoped, and just drive returns down even more!

‘It’s a matter of basic supply and demand: if you have more capital in the UK, then, other things being equal, the price of capital in the UK will fall…Investment is low in Britain because opportunities for profit are scarce. This is because costs are high.’

Earnings gulf

Barry Norris, manager of the VT Argonaut Absolute Return fund, makes the killer point: ‘There is no evidence to suggest that the UK stock market is any less efficient than any other in undervaluing investment opportunities.

‘Share prices – believe it or not – tend to follow or even anticipate shareholder profits. Whereas the earnings per share of the FTSE All-Share index have grown by 47% (in £ terms) over the last decade, those of the S&P 500 have risen by a whopping 156% (in £ terms).’

Bloomberg’s John Stepek provides a reasonable counter-argument that the UK ISA is not a bad idea but there may be better policy suggestions such as the idea of Peel Hunt’s Charles Hall for extending inheritance tax relief to listed small-and-mid-cap companies and abolishing stamp duty.

Stepek’s bottom line is ‘a British ISA would not stop anyone from investing abroad — they just might not get quite as big a tax break to do so.’ He adds: ‘If you believe in encouraging investment in the UK, then a healthy equity market is a means to that end.

‘If you believe in reducing wealth inequality and improving financial literacy, then a healthy UK stock market that enables and encourages auto-enrolled employees to participate in the success of fast-growing small companies is a means to that end. “

Quite reasonably the Association of Investment Companies has weighed in and suggested that UK-listed investment companies should be included in the new additional £5,000 allowance. That makes a great deal of sense, and I can see why say investing in say listed UK renewable funds will be a net win-win for the UK economy.

But if we allow in Renewables Infrastructure Group (TRIG ) then why shouldn’t we allow in say Alliance Trust (ATST ), or JPMorgan Global Growth & Income (JGGI )? If we allow these listed global equity funds, why shouldn’t we allow in global equity exchange traded funds? And if we allow in hundreds of UK-listed ETFs where do we draw the line on their exchange status? Retail bonds listed on the London Stock Exchange as well?

Where are UK’s growth companies?

The debate gets to the heart of the construction of the BritISA. The UK market has underperformed for many reasons but one of them is that we have a structural issue with the businesses listed on the market. Put simply, we don’t have enough growth stocks while we have too many boring, mature businesses – paying a dividend – or cyclical businesses whose underlying earnings stream is too volatile.

Now none of that means there aren’t many, many opportunities present in the UK market.

In a previous column on UK equities, I highlighted the fact that there are myriad opportunities for UK value managers. I stand by that comment but there aren’t dozens of good UK value managers and the few that have gathered significant assets under management face real headwinds.

Last week saw the release of the annual Global Investment Returns Yearbook from UBS. One of the charts in that tome by the academics Paul Marsh, Mike Staunton and Elroy Dimson, featured a scary one looking at the longest period over which factor premiums remained negative from 1900 to 1923.

One line showed UK value stocks suffering a 34-year negative premium from 1987 to 2020! Pity the poor ISA investor who wakes up in the 2050s and discovers the UK value premia have been non-existent for a few decades.

What’s to get excited about?

While value can deliver in the UK, the headwinds are not to be underestimated, and there is a real paucity of UK growth stocks. This leaves one wondering what exactly it is that UK investors can get excited about when they open their UK ISAs? 

One factor to the UK’s poor performance has been that our equity benchmarks are not fit for purpose. We all know that the FTSE 100 is not even remotely sensitised to the UK economy. The FTSE 250 by contrast was always supposed to be more UK-centric but the boom in investment companies over the last five years has produced a glut of mid-cap closed end funds which has contributed to that index’s recent underperformance.

What we all desperately need is a more UK-focused benchmark, preferably one with more growth stocks. For the UK ISA to work, we collectively need a properly diversified benchmark to work off and currently, FTSE doesn’t provide one. Time for the New ISA Opportunity Index me thinks.

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