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In his Autumn Statement speech, the Chancellor Jeremy Hunt announced that the government would sell its stake in high street lender NatWest Group. Harking back to a 1980s ad campaign which urged the public “if you see Sid, tell him” to invest in newly privatised British Gas shares, Hunt said the government may offer its NatWest shares to retail investors.
The government bailed out the bank, which was then RBS Group, in 2008 at the height of the global financial crisis, taking an 84% stake. In the years since, the government has steadily sold down its holding and now has 38.6% remaining. It will “explore options” for a retail share offer in the coming year with the aim of returning the bank to full public ownership by 2025-26.
But should the government be encouraging ‘Sid’, meaning the man on the street, to buy bank shares?
Shareholders in NatWest saw the value of their investments wiped out during the crisis and the share price has still not recovered to its pre-crisis level.
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One reason for this was that the new shares the bank issued to the UK government diluted old shareholders’ holdings. To ever get back to previous levels, profits for the lender would need to be many times greater than they were back in 2007. But large parts of the business were sold off and it moved from being a global bank to a just a UK bank, so the assets needed to create the profits no longer existed.
Banks are vulnerable to interest rate changes which can affect their borrowing costs and the amount they have to pay in interest to savers. In an environment of weak economic growth, they can start to face higher costs as borrowers default on loans.
There’s also great disparity in the performance of individual banks, and of banking sectors in different regions. This shows the importance of being selective when it comes to investing in bank stocks, and lends weight to the case for a diversified investment approach such as the one we follow at atomos.
For example, UK and European banks have performed well this year, but if we look at US banking stock performance, we see a sharp sell-off. There was a run on several specialist banks as consumers queued to pull their money out on insolvency fears. Three regional US banks failed in a five-day period in March, forcing regulators to step in, and the sector as a whole is still feeling the effects of the crisis. Banks face ongoing concerns around losses on government bonds they bought at low yields, rising deposit interest rates and short-term funding costs, asset quality, and their drag on net income.
The chart below highlights the average annual return of financials against the wider global stock market, showing they have typically underperformed since 2007.
We expect the high interest rate environment to continue to exert stress on the financial system over the next six to 12 months.
The point is, banks are fine until they’re not, and buying shares in a large utility company like British Gas (now Centrica) is not the same as buying shares in a high street bank, whatever Sid may think. Banks are big, complex beasts and analysing their assets and loan books is an extremely complex process. Banks are often compared to utilities but history has shown they are poles apart, given their sensitivity to the interest rates and the economy. And, of course, even so-called ‘stable’ stocks like utilities can be volatile – some investors in Centrica will have had a bumpy ride. At atomos we believe your portfolio should not hang on one or two big-name stocks, it’s important to remain well diversified portfolios to reduce risk.
An ‘Autumn Statement for growth’
In his Autumn Statement speech, Jeremy Hunt pointed to 110 measures designed to boost UK productivity and economic growth.
The Chancellor had £27bn of cash to deploy due to lower departmental spending in real terms (meaning accounting for inflation), better-than-expected growth and lower borrowing.
He spent this windfall on cutting National Insurance Contributions, tax write-offs for business investment, and a package of welfare reforms.
A rumoured cut to inheritance tax didn’t happen, but the government confirmed that the lifetime allowance (the maximum someone can save into a pension in their life without paying an extra tax charge) will be scrapped in April 2024. We are considering the implications of this change for our clients.
What do higher government bond yields mean for pensions?
From an investment perspective, financial markets seem to take the Autumn Statement in stride, with limited movement from sterling. However, there was a slight rise in UK government bond (gilt) yields, and this could have implications for pensions and retirement income.
Gilts yields (which move in the opposite direction to gilt prices) are influenced by various factors such as the outlook for inflation and economic growth. Higher inflation expectation and low economic growth tend to drive gilts yield higher as investors demand higher returns to lend money to the government.
If you’re thinking about retirement income
When gilt yields rise, annuity rates rise too. An annuity is a retirement product which gives you a guaranteed income, this is likely to increase when gilt yields are higher. That’s because the annuity provider earns a higher yield from holding gilts and can then pass that on to you. The Office for Budget Responsibility predicts inflation will fall back to the Bank of England’s 2% target by 2025, which would pull down gilt yields. This means someone near retirement may need to think about timing if annuities form part of their financial plan.
If you’ve got a final salary pension
Defined benefit or final salary pensions are provided by employers and provide a guaranteed income. These schemes are expensive for employers to maintain and they may offer a generous lump sum (called the transfer value) to incentivise people to move out of them.
Schemes typically rely on gilt investments to be able to meet their liabilities. When gilt yields rise, the cost of providing the income falls and the funding position of a defined benefit scheme improves, but transfer values fall. This means if you are considering transferring out of a defined benefit pension, you may find the transfer value has reduced in the last couple of years. The financial watchdog requires anyone with a defined benefit pension worth above £30,000 to take financial advice before transferring it, but it’s wise to seek advice whatever the size of your pot.
All investment views are presented for information only and are not a personal recommendation to buy or sell. Past performance is not a reliable indicator of future returns, investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice.