Pension Protectionism and the Folly of Home Bias

 The sources argue that home bias fails because it is a damaging and misguided strategy that undermines optimal investor returns, contradicts basic principles of diversification, and is based on flawed premises concerning the needs of the British economy.

In the larger context of "The Trouble with Home Bias in UK Investment," the author asserts that for most British savers, the optimal allocation to UK assets should be 0%. This position is based on the following core arguments why home bias fails:

1. Home Bias Undermines Investor Wealth and Risk Management

For individual investors, home bias fails because it reinforces domestic risk exposure and sacrifices better returns.

• Costly Patriotism and Lower Returns: The author highlights that for British investors, sticking money in domestically listed equities over the past decade resulted in total shareholder returns two-thirds lower than investing in a global index that excludes Britain, making "patriotism costly". A globally diversified return stream has historically been a higher-returning strategy with less volatility compared to focusing on one specific country.
• Existing Over-Allocation to the UK: Every individual's total "portfolio" already includes significant unavoidable exposure to the domestic economy through their home, the present value of future earnings, and potential state pension eligibility. Therefore, adding domestic investments only increases this overwhelming exposure.
• Reinforcing Shocks: The recent history of the UK serves as a case study: weak growth pulled down wages and British equities underperformed for the same reason. People could have chosen whether their investments reinforced that shock (by holding lots of British assets) or counterbalanced it (by holding global assets).

2. The Premises Supporting Home Bias are Flawed

The author systematically attempts to take apart the three main arguments used by successive British governments (including the rationale behind the Pensions Investment Review) to actively push for more domestic investment.

A. Premise 1: Lack of Domestic Capital Hurts Growth (Capital is a Bottleneck)

The author argues that the belief that high-return investments are being held back by an inability to attract investors does not hold up. Surveys of manufacturers show that the overwhelming issue preventing investment is a lack of sufficiently appealing opportunities ("uncertainty of demand," "inadequate return"). Worries about the "cost of finance" or "inability to raise external finance" were among the least popular responses.

• Britain's financial system is one of the deepest and most liquid globally, making it difficult to believe that vast, sophisticated international investors are foolishly overlooking countless exciting opportunities.
• Instead of forcing home bias, the way to attract capital is by making Britain a genuinely appealing economy, which would encourage both domestic and international investors to "pony up cash".

B. Premise 2: Having an Overseas Investor Base is a Problem

This premise fails because the concerns about low valuations and companies moving overseas are not strongly supported by evidence:

• Low Valuations: The claim that British equity valuations suffer due to a lack of a stable domestic buyer base fails a basic timing sense-check. The major upswing in foreign ownership occurred between the 1990s and 2010, while UK valuations only began lagging the US in the mid-2010s. The valuation gap is better explained by factors like the UK market's lower exposure to tech and the lingering "post-Truss hangover".
• Company Movement: Although there might be some small path-dependency for start-ups, the author argues that businesses are generally guided by business imperatives (such as the broader appeal of the larger American market) rather than the specific geography of their investors when deciding where to move operations.
• Non-Brits Profiting: The idea that having non-Brits profit from "British success stories" is a problem is considered spurious. What truly matters for economic growth is that productive activity is happening in Britain, regardless of who funds it.

C. Premise 3: Economic Effects Outweigh Lower Returns

The author contends that the negative effects of a policy mandating home bias outweigh the potential benefits for the economy. The adverse impact on the wealth of British pension-savers due to a worse-constructed portfolio could be material. The benefits of a better-funded pension system—including reducing pressure on the state pension and insulating households from shocks—almost certainly outweigh even the best-case scenario for mandation, which might, at most, slightly reduce the cost of capital for a few British firms.

Ultimately, the failure of home bias means that investors are accepting higher risk and lower returns for minimal or non-existent national economic benefit, while forcing fiduciaries to buy assets they would not otherwise have chosen, which raises questions about consistency with fiduciary duty.

The sources indicate that there is a cross-party governmental push for home bias and protectionism in the UK, which the author views as misguided and damaging to British savers. This push occurs within the larger context of "The Trouble with Home Bias in UK Investment," where the author argues that the optimal allocation for most British savers to UK assets should be 0%.

Methods of Governmental Push and Protectionism

Successive British governments, including the current Labour Party, have actively promoted increased domestic investment, which the author describes as "pension protectionism".

1. Pensions Investment Review and Backdoor Mandation: The most recent example is the Pensions Investment Review, which reaffirmed the government's position in favor of home bias. Although the government decided against explicit mandation (forcing schemes to hold a certain share of British assets), it is creating a "reserve power" to force mandation later. This is viewed by the author as "backdoor mandation"—using the threat of force to pressure pension funds to "voluntarily" allocate money within Britain anyway. The author notes that this refusal to acknowledge tradeoffs and forcing fiduciaries to buy assets they would not otherwise have chosen raises questions about consistency with fiduciary duty.

2. Tax Incentives (Brit ISA): The Conservative government previously attempted to use tax policy to encourage domestic investment through the "Brit ISA," a now-ditched tax break designed to persuade ordinary people to buy more British shares, stemming from similar thinking.

3. Cross-Party Enthusiasm: The push for home bias is not specific to one party, as both Labour and the Conservatives have shown enthusiasm for this policy, suggesting a consensus that the sources attempt to challenge.

The Core Economic Rationale of the Government Push

The government's enthusiasm for forcing home bias is based on three main planks, all of which the author attempts to dismantle:

1. Addressing a Capital Bottleneck: The belief that a lack of domestic capital hurts growth because good projects and companies are being held back by an inability to attract investors. The sources argue this premise fails a sense-check, as surveys show that the main issue is a lack of appealing opportunities ("uncertainty of demand," "inadequate return"), not difficulty raising finance.
2. Fearing Overseas Investor Base: The idea that relying on foreign capital is a problem because it leads to low valuations and encourages promising companies to move overseas. The author argues that low valuations started lagging the US long after the main upswing in foreign ownership occurred, and that companies are guided by business imperatives (like market size) rather than the specific geography of their investors. The author calls the concern over non-Brits profiting from "British success stories" spurious, noting that productive activity matters more than the origin of the funding.
3. Outweighing Lower Returns: The premise that the economic benefits (like reducing the cost of capital for British firms) resulting from increased domestic investment are substantial enough to outweigh the cost of lower returns for British savers. The author views this as highly unlikely, arguing that the cost to savers' wealth from a "worse-constructed portfolio could easily be material". The huge benefits of a better-funded pension system—like better insulating households from shocks—almost certainly outweigh the best-case scenario for mandation.

Context of Financial Protectionism

The author places this UK government action within the broader context of financial protectionism, noting that the effort to use state power to influence cash flow across borders resonates with other, more extreme, international proposals, such as a bizarre tax provision in a proposed Donald Trump bill that sought to tax income flowing abroad.

In short, the government push for home bias is seen as a form of pension protectionism driven by flawed economic premises, which results in the threat of coercion against fiduciaries (pension funds) and undermines the principle of securing the highest returns for British savers.

The sources provide a comprehensive refutation of the three main premises used by British governments to justify the push for increased home bias in investment. This refutation forms the core of the argument that home bias is a "damaging and misguided" strategy within the larger context of "The Trouble with Home Bias in UK Investment," where the optimal allocation for most British savers to UK assets is asserted to be 0%.

The three premises and their refutations are detailed below:

Premise 1: Capital is a Bottleneck to Growth

The Premise: This argument suggests that a lack of domestic capital hurts growth because high-return infrastructure projects, expansions, or start-ups are being held back by an inability to attract investors.

The Refutation: The author argues that this premise fails a basic "sense-check" by looking at the reasons companies themselves cite for not investing more.

• Lack of Opportunity, Not Funding: Surveys of manufacturers (specifically the CBI’s Industrial Trend Survey) show that the overwhelming issue preventing investment is a lack of sufficiently appealing opportunities, citing "uncertainty of demand" and "inadequate return".
• Financing Is Not the Problem: Worries about financing—such as "shortage of internal finance," "cost of finance," or "inability to raise external finance"—are consistently among the least popular responses.
• Deep Financial System: Britain's financial system is described as one of the deepest and most liquid in the world. The author finds it difficult to believe that "vast, sophisticated international investors are foolishly overlooking countless exciting opportunities".
• Solution is Economic Appeal: The way to attract capital is not through coercion but by making Britain a "genuinely appealing economy," which would encourage both domestic and international investors to "pony up cash". The author also points to "straightforwardly damaging real-economy bottlenecks" like the planning system as the true obstacles to growth, not a lack of finance.

Premise 2: Having an Overseas Investor Base is a Problem

The Premise: This argument posits that relying on foreign capital is detrimental because it leads to low valuations for British equities, and promising companies may eventually follow their overseas investors and move operations abroad.

The Refutation: The author challenges this premise by addressing the three specific concerns associated with foreign ownership:

• Low Valuations: The claim that British equity valuations suffer due to a lack of a stable domestic buyer base is refuted by a timing sense-check. The major upswing in foreign ownership occurred between the 1990s and 2010, yet UK valuations only began lagging the US from the mid-2010s onward. The valuation gap is better explained by factors like the UK market's lower exposure to tech and the lingering "post-Truss hangover".
• Company Movement: While acknowledging some path-dependency for start-ups, the author is "not sold" that investor location specifically (as opposed to the broader appeal of the American market or business imperatives) is a huge factor in where companies move their operations. The "broadly reasonable baseline" is that businesses are guided mainly by business imperatives.
• Non-Brits Profiting (Spurious Logic): The idea that non-Brits profiting from "British success stories" is a problem is called "spurious". The author asserts that what really matters for economic growth is that productive activity is happening in Britain, not who funds it. Furthermore, if British investors have chosen to invest elsewhere because that option had the highest expected return, Britain is not the loser in that interaction.

Premise 3: Economic Effects Outweigh Lower Returns

The Premise: This argument asserts that the economic benefits gained by forcing domestic investment (e.g., reducing the cost of capital for British firms) are substantial enough to outweigh the cost of achieving lower returns for British savers.

The Refutation: The author argues that the negative impact on saver wealth far outweighs any potential benefit:

• Material Cost to Savers: If markets are even moderately efficient, the positive effect sizes of a mandation policy (reducing the cost of capital) are tough to see as "all that large". Conversely, the impact on the wealth of British pension-savers of a "worse-constructed portfolio could easily be material".
• Patriotism is Costly: For British investors, sticking money in domestically listed equities over the past decade resulted in total shareholder returns two-thirds lower than investing in a global index that strips out Britain.
• Benefits of Well-Funded Pensions: The author argues that the huge benefits of a better-funded pension system—such as reducing pressure on the state pension and better insulating households from shocks—almost certainly outweigh even the best-case scenario for mandation.

The sources strongly imply that alternative solutions for UK growth should focus on removing real-economy bottlenecks and making the British economy genuinely appealing to capital, rather than pursuing misguided policies of home bias or financial protectionism. These alternative solutions address the root causes of underperformance that home bias policies fail to solve.

Within the larger context of "The Trouble with Home Bias in UK Investment," the author argues that the focus on coercing domestic investment is misplaced, as the primary barrier to growth is not a lack of finance (Premise 1: Capital is a bottleneck) but a lack of appealing opportunities.

Key Alternative Solutions for UK Growth

The sources identify several non-financial policy areas that would be more effective in stimulating growth and attracting capital than mandated home bias:

1. Reforming the Planning System (Addressing Real-Economy Bottlenecks)

The most emphasized alternative solution is addressing "straightforwardly damaging real-economy bottlenecks" like the planning system.

• Impact on Investment: The sources note that investors would be keener to put money into Britain if it were easier to build. The sources cite an extreme example where getting approval to build film studios on a former landfill in Buckinghamshire required over four years and the personal intervention of the Deputy Prime Minister.
• Housing Crisis Connection: The planning system is also implicated in the UK's housing crisis, which is a major drag on the economy. The current system allows existing home-owners (NIMBYs) to fight building proposals, sometimes over trivial concerns, delaying projects for years. The sources advocate for gutting the Planning Act and starting over, pushing for a default "yes" to applications and setting a clock to prevent endless delays. This is viewed as an "almost no fiscal cost growth lever" that political parties are failing to pull.

2. Making Britain a Genuinely Appealing Economy

Instead of focusing on mandating domestic cash flow, the true solution is to improve the underlying economic environment:

• Attracting Capital: The sources state that the way to attract capital, both domestic and international, is to "Make Britain a genuinely appealing economy". If the economy is appealing, investors will "be happy to pony up cash".
• Addressing Demand and Returns: The most overwhelming issue preventing investment is cited as a lack of sufficiently appealing opportunities ("uncertainty of demand," "inadequate return"), not a lack of finance. Therefore, policies that improve demand certainty and expected returns are the real path to growth.

3. Revitalizing Capital Markets (Tax Reform)

While the main focus is on the real economy, the author flags specific financial policy changes that would genuinely help British capital markets, unlike home bias:

• Abolishing Stamp Duty on Shares: The sources flag stamp duty on shares, a 0.5% financial transaction tax, as a policy that should be discussed more often. Unlike pension protectionism, there is "fairly persuasive evidence that this tax depresses the prices of UK-listed equities".

4. Focusing Pension Policy on Highest Returns

Although not a direct growth lever for the broader economy, an alternative solution for the pension system itself is prioritizing investor wealth:

• The author argues that the single guiding question for pension policy should be: "what needs to be done to make sure British savers are getting the highest returns in the world?". The massive benefits of a better-funded pension system—reducing pressure on the state pension and insulating households from shocks—almost certainly outweigh the marginal benefits of mandation.

In summary, the sources suggest that the government's energy is misdirected toward financial protectionism (home bias), when it should instead be focused on removing physical and regulatory impediments that discourage both domestic and international investors from seeing genuine, high-return opportunities in Britain.