ISAs: Calls mount for overhaul of rules to reignite UK stock market

Pressure is mounting on the new Labour government to simplify the ISA rules in order to reignite the UK equity market and channel more money into British stocks.

Broker AJ Bell has written to Chancellor Rachel Reeves urging the government to consider a “radical” overhaul of ISAs as well as implementing tax breaks for UK stocks to unblock the British stock market.

The move comes after a record £1.8 billion was withdrawn from UK equity funds in May, marking the continuation of a bruising period for the country's stock market. 

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AJ Bell wants the government to create a single ISA product that incorporates cash ISAs, stocks and shares ISAs and junior ISAs. It also wants Reeves to consider increasing the overall ISA allowance from £20,000 to £25,000.

Michael Summersgill, chief executive of AJ Bell, says: “AJ Bell has campaigned for radical ISA simplification for years and wholly supports Labour’s intention to pursue fundamental reform in this area. By combining the best features of ISAs into a single product, the government can make it easier for people to take the first step into long-term investing. 

“These reforms could be undertaken at limited cost to the taxpayer and the potential prize is substantial.”

Summersgill adds: “Creating a genuine incentive to invest in UK assets, such as by scrapping stamp duty on UK investments, would also help.”

According to figures from the Investment Association, the industry body, almost £55 billion has been withdrawn from UK equity funds by retail investors since 2016.

Laith Khalaf, head of investment analysis at AJ Bell, says: “May was the worst month on record for UK equity fund flows, quite the accomplishment for a sector that has been in outflow for eight years. Even more troubling for UK asset managers is the fact the trend seems to be accelerating.”

What is causing the UK outflows? 

The Investment Association says: “Diversification of portfolios remains a driving factor in UK equity outflows. Investors and their advisors continue to reallocate outside of the UK, with strong inflows for global, Europe and North American funds.”

In stark contrast, flows into US funds have been stellar. North American and global funds attracted £7.8bn and £7.58bn respectively in the first six months of 2024, according to separate data from investment software provider Calastone.

The rise of passive investing has also been detrimental to flows into the UK. Khalaf says: “Tracker funds have seen the lion’s share of inflows across the industry. But passive investing logically favours a global approach, and with the UK representing just 4% of the MSCI World Index, not much of the huge wall of money invested in trackers is benefiting UK stocks.”

Weak performance from active managers, Khalaf adds, “stemming from the hegemony of a clutch of large technology stocks, combined with a focus on cost and simplicity, means the rise of passive investing almost certainly has further to run”. 

Will UK stock sentiment recover?

Many analysts have highlighted that London Stock Exchange-listed companies are looking cheaper than US rivals.

Michael Brown, chief investment officer at Martin Currie, highlights that real wage growth and employment data in the UK have both beaten analyst expectations. Furthermore, the country's Manufacturing and Services Purchasing Managers' Indices have all turned positive unlike its European neighbours.

“The international perception of the UK is changing,” says Brown.

“A change of government, to one more moderate and international in tone, coupled with a deterioration of European political stability, notably in France, indicates that there remains room for sterling to appreciate. This would be beneficial for lowering inflation rates even further.”

He suggests that sterling could be boosted by the Bank of England taking its time on rate cuts.

“At the same time, a reduction in the risk premium for UK assets could accelerate sterling’s move and positively surprise the equity market,” he adds.