Arm signals a sea change in City, says HAMISH MCRAE

It’s stunningly bad news for Britain that Arm chose to float in New York rather than London, but it shouldn’t come as a surprise. It gets a higher rating there.

Follow the money. But that raises the question of why the same company – the UK’s only significant competitor in the big tech world – would be worth more if launched in one city rather than another.

People will come up with all sorts of reasons including the rules of the Financial Conduct Authority, the UK remains an old fashioned place to invest and the market is narrower. But I think the explanation mainly boils down to this. The two main classes of UK institutional investors – pension funds and insurance companies – do not invest in UK companies.

The most recent figures come from the Office for National Statistics (ONS) which, as I pointed out a few weeks ago, shows that UK pension funds own just 1.8% of UK listed securities, while insurance companies only own 2.5% . Individuals own 12 percent and mutual funds (mostly owned by individuals) another 7.4 percent. So who owns Britain? Well, other financial institutions had 12.8 percent, but the lion’s share are foreigners: at the end of 2020, they held a record 56.3 percent of all publicly traded shares.

This is extraordinary. For starters, the statistics do not support the accusation that foreigners have stopped buying shares in UK-listed companies because of Brexit. In 2016, they controlled 53.9 percent of the UK market, so they’ve actually increased their holdings ever since.

What happened goes back 25 years, because in 1997 insurance companies controlled 23.6 percent of the market. That was the highlight. The ONS does not break down the share of pension funds, but it will be broadly comparable. That’s why, since 1997, we’ve come up with a set of rules and tax incentives that have pushed our institutions to stop investing our depositors’ money in our own businesses. Getting worse. Not only have they stopped investing new money in the UK market, they have also taken their money out. Given that the bodies that once owned half the market have been relentless sellers for 20 years, it is not surprising that the FTSE 100 should move sideways.

So where has the money gone? It’s complicated, but the simple answer is that changes in regulations and taxes have led them to put money into government bonds and other fixed-income securities, using all sorts of complex derivatives to try and boost returns.

Given that the past two decades (at least until 18 months ago) have been a period of falling interest rates and low inflation, that strategy hasn’t worked too badly for the institutions, even if it has been a disaster for investment in the shares of UK companies – and thus the attractiveness of a listing on the London Stock Exchange. But that period of ultra-low interest rates is over. So let’s look ahead.

In the very long term, you always achieve a higher return on shares than on fixed-income securities. The new Credit Suisse Global Investment Returns Yearbook shows that over the past 122 years in the UK, equities have returned 5.3% annually in real terms, while government bonds have returned 1.4%. But the past 30 years have been unusual in that fixed income investments have outperformed equities almost as well.

The authors calculate that since 1990 the return on a global fixed-income portfolio has been the same as on a global equity portfolio: 4.2 percent.

But looking ahead to the outlook for Gen Z, they predict equities will deliver a real return of 4 percent, while they expect only 1.5 percent for fixed income. The old rule that shares yield better returns than government bonds is back.

If they’re right, and I think they’re right, this will have huge implications for equity investing everywhere, but particularly in London – for two reasons. One is that it offers much more value than most other markets. The other is that the depressing effect of UK institutions taking money out of UK stocks is over.

They can no longer withdraw money because they have no more investments. In fact, they will have to start rebuilding positions now because savers will want to know why their money is being put in government bonds when they would get better returns on stocks.

I don’t see this mood swing happening in time to help Arm get listed in London and New York. But make no mistake. A big change is coming and we should take this failure as a wake-up call if London is to take full advantage of it.