PIERS HILLIER, CIO of LV= Asset Management on Asset Allocation
If the 1990s epitomised the cult of equity, so the 2000s should go down as the cult of debt. But what cult classic will we be celebrating at the end of the 2010s?
The answer may lie in what happened in 1987 – the introduction of the Financial Services Act, the ‘Big Bang’ changes in the operation of the stock market, the start of Personal Equity Plans and the continuation of the privatisation programme.
The unintended consequence was a 186% return from the FTSE 100 over the decade of the 1990s equating to a return over 11% per annum.
1997 heralded the first Labour government for almost 20 years, which made three substantial changes – what I have termed the Good (it established independence of the BoE to set interest rate policy), the Bad (it created of the FSA as ‘super’ regulator), and the Ugly (it removed the dividend tax credit for pension funds).
The Good has been well documented and continues to operate effectively today, while the Bad is under review after it failed to regulate banks effectively and allowed the propagation of the biggest liquidity crisis since the Great Depression.
However, the Ugly remains and has seen the annihilation of DB pensions and the most dramatic asset allocation shift from equity to bonds since WWII. The average DB pension fund has moved from around 70% allocation to equities in 2000 to around 70% allocation to bonds in 2010.
Arguably, both are extremes. However, the unintended consequence has been a total return of 13% from the FTSE 100 over the decade of the 2000s equating to a return of 1.2% per annum.
I would suggest we look at the changes in corporation tax and its future trajectory. 2007 saw the first cut in corporation tax, from 30% to 28%, for almost a decade.
The coalition government has proposed further cuts in corporation tax rates by 1% per annum for the following four years such that the rate will be 24% by 2015. This is interesting when we look at the path of corporation tax in the previous two decades. In the 1990s, corporation tax rates fell from 35% to 30% while in the 2000s the rate remained at 30% for most of the decade.
However, during this decade, the rise in employers’ national insurance contributions created a net effect of a small rise in the net corporate tax burden.
While corporation tax rates alone do not drive equity returns, it is evident lower rates contributed to the additional returns equity investors enjoyed in the 1990s relative to the 2000s.
With corporation tax set to fall 4% and employers’ national insurance also cut 1% in 2010, the unintended consequence for equities to offer an attractive return to investors has been created.
Piers Hillier is CIO of LV= Asset Management
