Should ISA investors be forced to hold UK shares?

Speculating about what will be in this year’s Budget is fairly pointless, not least because the plans clearly change every few days. But the persistent chatter that the chancellor would like to coerce or persuade private investors to hold a minimum level of UK stocks in their individual savings accounts (ISAs) is worth a brief thought. To declare my bias, I think this idea is daft and not just because of the headache of deciding what’s British enough. International miner Anglo American after it moves its headquarters to Canada? An investment trust with half its assets in Asia? An exchange traded fund that tracks the S&P 500? The ISA rules are already full of nonsense – we don’t need any more.

The idea that ISA tax relief should be a quid pro quo for investing in British stocks misses the point. ISA and pension tax relief exists to get people to put aside money for their retirement and other needs. That money should be invested according to the balance of risk and reward for each investor. If that means no UK stocks, that is still the right outcome. If the government wants to save the UK market, it should work out why firms don’t want to list and investors don’t want to invest voluntarily, and fix that. Coercion is never going to be a better option than solving the underlying problems.

ISA investors are already heavily invested in the UK stock market

Yet it still raises a good question. What is a neutral level of investment in British stocks? Well, the UK is about 3.5% of the MSCI World index of developed markets. That’s a starting point. However, these indices have their own skews: they are affected by the high valuation of US markets (America is now 73% of the MSCI World) and by restrictions such as free float. For a different perspective, look at equal weight indices, where valuations and free float don’t matter: instead, they broadly reflect the number of stocks in each market and so the number of opportunities available for investment. The MSCI World Equal Weighted index has about 5.5% in the UK (the US is about 41%).

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So one way of looking at this is that neutral exposure to the UK is somewhere around 5%. It would be less if we factor in emerging markets, but we get into some complications over access restrictions, so let’s keep this simple.

How much does a typical ISA investor hold? You’d think this would be easy to answer, but it’s not. While HM Revenue & Customs asks ISA managers to report how much is held in different investments, the categories it asks for are a baffling, outdated and overlapping hotchpotch that at no point simply says “UK shares”. However, ISA investors have 23% of their total holdings in UK equities and by inference about a third of their equity holdings in the UK, according to data compiled by the Investment Association and provided to Bloomberg. You can find other figures, but the story is consistent: ISA investors are already overweight the UK. Maybe that makes sense – the UK has held its own against the world ex USA in recent years. But we don’t need to be forced to hold more.

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