Hope springs eternal

Sometimes, I’m inclined to open my mouth and say something really daft. Thus, it was a couple of weeks ago at a team meeting to discuss ideas for editorial pieces that the words “how about a piece on whether governments should intervene in markets or not?” escaped my lips.

To my surprise and slight concern, the title got added to the schedule and I can’t help thinking it’s a punishment for something I have, or haven’t, done. After a lot of pacing up and down, drinking of coffee and sleepless nights, I’ve concluded that in these polarised political times, there’s probably no way to get to the end of this piece without causing disagreement.

But I think the Kepler readership is civil enough to agree that disagreement and debate is something that people like us can embrace and maybe even enjoy. So here goes.

I think it’s fair to say we are living in an era of rapid social change. So, perhaps, it would be helpful to think about another time in history when society was evolving at speed. Let’s travel back to the 1940s, a period of history that continues to shape how the world looks today.

One of the keys to understanding the Second World War is to think about how one motivates an army of people from a democratic society, overwhelmingly comprised of people with no interest in military service.

Motivating an army from a totalitarian society just requires leaders to be, ahem, totalitarian, but how do you get people from a democracy to put their own personal interests aside, to the point where they may have to lay down their lives?

Many readers will be familiar with the Western Allies’ philosophy of ‘steel not flesh’, which, simply put, means more tanks, artillery, aircraft, machinery and firepower per person. Any assessment of how the Second World War was fought is enlightened by the understanding that the commanders of the Western Allies had to show a much higher regard for the lives of their own soldiers than their totalitarian counterparts for their soldiers, in order to get the best from them. And, of course, exactly the same contrast is playing out in Ukraine today.

Alongside applying industrial might, there are a couple of other things which are important to think about: ‘What is it we are actually fighting for?’ ‘What kind of society are we returning to afterwards?’

It’s very easy to forget the Second World War’s close proximity in time to the Great War, when a generation came home after an indescribably awful war to receive the gratitude of the King and very little else. This was a living memory in the 1940s and wise politicians knew they couldn’t pull the same trick this time.

Now don’t worry, we are just a few sentences away from investment trusts, but to finish the story, the end of the war was the beginning of social change that still influences our lives today in very real ways.

Younger readers less interested in history may be surprised to learn that almost the first thing the British people did was vote Winston Churchill out of office. How could this be? The singular focus he had on winning the war meant that he spent very little time thinking about what came next, and in 1945 this really mattered to people.

Many people will know the big event that followed was the founding of the National Health Service in 1948, which continues to shape our society today. This was one very large answer to the question ‘what kind of society will we return to?’ 

One of the other things that happened in 1945, against this backdrop of social change, was the adoption of an idea first put forward in the 1930s by, among others, John Maynard Keynes. The Industrial and Commercial Finance Corporation (ICFC) was founded by the Bank of England and a group of large banks to provide finance to small and mid-sized companies that struggled to raise capital from other sources. This sounds like a familiar problem, doesn’t it?

The very short version of quite a long story is that 3i Group (III), as ICFC became, floated on the London Stock Exchange in 1994, adopting the investment trust structure that we all know and love. 3i Group and its predecessors were fixtures in the regional UK business landscape for decades, a first call for growth capital for small and medium-sized companies.

Today, 3i Group’s market capitalisation is almost £17bn and, as well as its own balance sheet capital, it manages many more billions in other funds. It’s a long time since it outgrew its original role, and it is an extraordinary success story.

Anyone with just a small amount of money can invest alongside a world-leading private equity firm on exactly the same terms as an institution, which seems rather in keeping with the times in which 3i Group was founded.

At this point, one might be thinking that this is a long-winded way of saying ‘we need more of this kind of strategic thinking today’ and, yes, we’ll come to that. However, as mentioned above, it’s been a long time since 3i Group outgrew its original role, but the need for that role never went away.

In 2011, the government at the time ‘helped’ a group of large UK banks, who themselves had been ‘helped’ by the government to weather the financial crisis, to decide to form an independently-run investment firm called BGF Group, which in many ways looks and feels like an earlier incarnation of 3i Group.

You can’t, yet, buy shares in BGF Group or buy a fund that it manages. However, it’s highly likely that if you own any of the UK Smaller Companies investment trusts, you are indirectly investing alongside BGF Group, which provides growth capital to both listed and unlisted UK companies through its network of regional offices.

One of the heartening things about the story above is that the foundation of those two organisations, separated by many decades, took place in different political times, with governments of different hues.

The evidence of long-term success of one of them was enough for someone to take the idea and repurpose it, without, it would seem, much of the fanfare that the weary cynic typically expects from government. It can’t be easy to be a long-term strategic thinker in government these days, so full credit to all concerned.

It seems to me that the UK is at a point in its history when it’s asking itself a similar question to the one posed by society at the end of the Second World War. ‘What is it that we really want to be?’ We, as a team, made a list of some investment-based objectives that we think any government would like to achieve. I’ve pruned the list down for the sake of brevity. None of them can possibly answer that question on its own, but perhaps each is an element of an answer. Many of them have specific links to our own investment trust sector. Against each one, we’ve provided our somewhat qualitative assessment, in italics, of how government is doing.
 

• Build more affordable homes to a higher standard and make them more energy efficient. We all know that the number of houses the UK needs to build that is routinely touted as the government target does not match with reality. A few years ago, a government agency was a founder investor in PRS REIT (PRSR). Arguably, without that investment, this REIT would not have succeeded in being listed. Recently, it completed its 5000th home for the private rental sector. It is an example of a direct government investment, on the same terms as everyone else, that has delivered a measurable result.
• Build more renewable energy to first, move UK to net zero, and second, lessen our dependence on global markets for our own energy. Regular readers know that Kepler views the Renewable Energy and Infrastructure sector as an outstanding success for the investment trust sector. Without government subsidies for renewables in the early days, it’s doubtful that this sector would have developed, as those subsidies were structured in such a way as to make risk for investors more predictable. Many of those contracts remain in force today. Further, one of the constituents of the sector, Greencoat UK Wind (UKW), was assisted with capital from the Green Investment Bank, which, although now independent, was at the time a UK government body.
• Build more infrastructure: schools, hospitals and libraries and maintain and upgrade the existing infrastructure. Again, we know that without government intervention, the listed Infrastructure sector may never have existed. Although some of the government-designed structures that provided the catalyst have been somewhat discredited and quietly dropped, this should not detract from the fundamental point that private capital has flowed into this sector as a result.
• Get more risk capital to growing smaller businesses. See above on 3i Group, of course, but also we should acknowledge the important role that VCTs play at the very-small end of SME investing. The rules for VCTs are, however, subject to periodic tinkering and have resulted in a sector that is complicated for a fund manager to work in. Consequently, this may deter some specialist fund managers who have the right skills at this end of the market. Naturally, the UK Smaller Companies sector also plays an important role in providing capital at the listed stage.
• Give retail investors a level playing field with institutional investors, so that they can save and invest in alternative assets, commercial property, private equity, venture capital, etc. To end on a slightly light-hearted note, we think the investment trust sector covered that one off in 1868, and continues to do so. Strange then, that investors must pay stamp duty on share dealing in this extraordinary contributor to the UK economy, over such a long period. I’m sure we’d all be delighted to see an intervention on that issue.

 
Now, we do know that there are bumps along the way in long-term investment and readers will no doubt be able to think of some bumps in the list above. Investment does involve accepting risk and any long-term assessment needs to think about whether those ‘bumps’ are specific or systemic before reaching any conclusions.

To conclude, it’s obviously not possible to analyse and diagnose what role government and markets can play in the space of a couple of thousand words, but maybe it is possible to make a couple of important points.

I chose the history lesson to highlight that real investment success takes time, maybe decades, and perhaps in the context of the above, it also takes acts of selflessness. History probably has recorded somewhere who actually made 3i Group a reality, who signed off on VCTs and who designed feed-in-tariffs – but, if it has, it’s not widely known about.

So, it’s not necessarily the headline-grabbing spectacular projects, which seem beloved of all governments, that ultimately make a difference. Rather, just consistency and long-term thinking. I would hope that those characteristics form at least some of the answer to the question “what do we want to be?”