In the City
The equity question mark
Nicholas Davenport
The share markets on the Stock Exchange are very sick. Turnover has dropped to the point where many stockbrokers cannot cover their expenses. Prices have fallen sharply despite the low turnover. In fact, the FT index of thirty industrial shares is around the lowest point of the year (365), having slipped from.421 since May. All this in spite of the fact that the analysts are predicting a recovery of 30 to 35 per cent in industrial profits this year, that the OECD reports the world economy as 'approaching the stage at which recovery frequently starts getting out of hand', that the new prime minister is putting his lefties in their place (which is outside the corridors of power) and is insisting that the private sector must remain prosperous in a mixed economy (otherwise it won't invest). The market apathy reminds one of a theatre audience freezing up on a first night when it is expected to laugh and cheer. Can it be that the equity share is losing its appeal and is going out of investment fashion ?
A particularly depressed area is the market in investment trust shares. These have certainly gone out of fashion. There has been a constant stream of sellers, and chief among them have been the 'institutions' who used to buy investment trusts for their income accumulation and the wide distribution of investment risks they offered, not to mention the appreciation expected from the higher gearing of their capital. What has gone wrong? This question was asked almost plaintively by Mr J. R. Henderson, the chairman of the Witan Investment Company, reviewing his company's accounts for the year to end-April. In this period, when the share market indices of London, New York and Tokyo rose by 21, 16 and 5 per cent respectively, the shares of Witan were unmoved and the discount on their net asset value widened to 38 per cent. I have heard a stockbroker say that so little do the 'institutions' now regard investment trust managements that they incline to treat investment trust shares as jobbing factors, selling them when the discount on net asset values falls to near 30 per cent and buying them only when the discount moves over 45 per cent.
The investment trust managements have largely themselves to blame for the bad behaviour of their market. They flooded it with £500 million of new issues in 1972 when the going was good, they got caught out by the 1974 slump and did not jump in early enough or heavily enough on the 1975 boom, and they had a bad ride on the dollar premium, having to buy more premium dollars at the top when they had to add to their collateral on their dollar investment loans. But most professional managers in this difficult period were as bumbling as the investment trust directors. The 25 per cent grab by the Treasury of the dollar premium sales has made the expert management of non-sterling funds virtually impossible.
What gave investment trust managements a bad name was their past. They derive from what I have called 'the old boys brigade' in the City—the closed shop of finance directors from the old Etonian families in the merchant banking and stockbroking worlds. The fact that investment trusts have not sought the obvious way out of their appalling discounts—by amalgamations and by exchanging their shares in a closed-end fund into units in an open-ended unit trust— suggests that these family managements are not anxious to give up the management fees of the 'old boys brigade'.
The group of investment trust shares is quoted today at around £2,200 million—a small proportion of the total valuation of £225,221 million for the whole collection of equities dealt in on the Stock Exchange. Most of these shares are selling at a discount on their net assets. But the private investor seems to be no longer interested in buying cheap assets through the share markets. He has shown his complete disinterest by turning his nose up at recent new issues. Underwriters had to take up 984 per 'cent of the Borthwick issue, 70 per cent of the Wilson Walton, 57 per cent of William Leech and 77 per cent of the £10 million Molins issue— a highly successful manufacturer of machinery for tobacco-making. The 'institutions' have been left holding the new issue babies.
It may well be argued that the reason why the equity share market appears to have gone out of favour is that the weight of new issues has stifled it and smothered its backers. Last year the amount of new issues raised through the Stock Exchange (Midland Bank figures omitting government issues) was close on an unprecedented £2,000 million (against £584 million in 1974) and in the first seven months of 1976 no less than £1,159 million. (Mr Jack Jones's criticism of the City not caring about industrial investment should die on his lips when he mouths these figures.) Until these new issues are digested the market is not likely to go ahead.
There is another reason for the equity inertia—the competition from the `tap' issues in the gilt-edged market. To finance the budget deficit the Treasury has to make as many issues of 'tap' stock as it can to the non-bank public in order to avoid inflating the money supply, and last year it got away with over £6,000 million net and in the first half of 1976 with £2,400 million net. The 'institutions' took up over £2,500 million last year and so far this year about £1,500 million. The yields offered by the Treasury are too good to reject-14.3 per cent on the last long lap' of Exchequer 131 per cent 1996 against 5.9 per cent on the average dividend-paying equity. This reverse-yield gap has got to be narrowed before the institutions change their investment policy.
It may be many years before the borrowing requirement is eliminated, but if Mr Healey succeeds in getting it down to £9,000 million in 1977-78 and then puts £5,000 million as the next target with a lower rate of interest, the resulting boom in gilt-edged would quickly narrow the reverse yield gap). In the old days of the 'equity cult', which I never expect to see return, they used to compare the average earnings yield on equities with the yield on 'long' gilt-edged. That made sense when there was no limitation on the increase in dividends. A pension fund buys an equity for the growth in income which it can never get from gilt-edged stock. To restore the equity market to its proper function the 10 per cent limitation on dividend increases must be removed.
Hoare Govett, the brokers, have produced some fancy figures for the disposal of institutional funds this year showing that the insurance companies will have £2,700million and the pension funds £2,900 million to invest and that they will put less in equities— £1,550 million—and more into gilt-edged— £3,180 million. I would question these figures but would agree with them that the equity share market is now dominated by 'institutional' policy. The Diamond Commission on income and wealth revealed that there were now eleven million pension scheme members and fourteen million life insurance savers. There are only about two million individual shareholders left. So the life and pension fund managers are the dominant equity market men. Their holdings must now account for over 50 per cent of all equities. For them the equity is no longer a cult but a headache.
PS. The correction of a misprint in last week's column allows me to add a rider on the rate of interest the outcome of which will affect institutional investment policy. The sentence should have run: 'I was sorry not to hear Mr Healey saying that getting cheaper money was really more important than getting expenditure cuts'. The Treasury last issued a short 'tap' on a yield basis of 114 per cent. The present Treasury bill rate of close on 11 per cent means a charge on the floating debt, which is around £11,500 million, of over £1,200 million a year. As the public sector debt service has already risen to 6 Per cent of the gross domestic product it is clear that bringing the rate of interest down should be the Chancellor's first priority. The potential rise in the gilt-edged market on that achievement should make the institutions give preference to bonds for some time to come. But in the long run, if Britain is to survive, equities must boom. Their bull market has not ended ; it has not yet begun; but it is still a long way off.
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