InvestmentsSep 26 2017

Investors can take advantage of governmental stupidity

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Investors can take advantage of governmental stupidity

Productivity is the key to economic growth. It is a simple concept, if difficult to create and measure. It means either producing more with the same quantities of input – such as labour, equipment, machinery and communication – or producing the same amount, but with smaller inputs of some or all those factors of production. 

Importance of productivity

Productivity is the difference between those economies and companies that are prosperous and successful, and those that are not. Britain is among the least productive nations in Europe – not the ideal position from which to take on the world once Brexit happens. 

It takes Britons five days to produce what French workers can do in four, and Germans, Dutch and Swedes possibly do in even less time. 

The source of productivity is infrastructure and basic education. Britain is bad at both, yet government ministers and civil servants appear to be oblivious to this. 

According to a FT feature on the UK’s ailing infrastructure: “The UK has an infrastructure problem. For a nation that drove the industrial revolution, it is disheartening that a lack of political leadership has left Britain with crucial parts of its infrastructure crumbling.

“Overcrowded and unreliable railways, an inconsistent and often slow broadband network, a crisis in housing stock and questions over energy security all point to a failure by successive governments to set clear, strategic priorities and accept the need for the public sector to play a bigger role in financing them.”

In 2016, the World Economic Forum ranked the quality of the UK’s infrastructure as 24th in the world; down five places in a decade. Britain has a middling rank among industrialised countries, but comes almost last out of the G7 nations, second only to Italy. 

There is a growing consensus among business leaders and economists about what, and where, reform is needed. Politicians do not share this understanding. 

Why London is richer

Low skill levels and inadequate communications infrastructure are blamed for poor economic performance and lower household incomes outside London. London and the South East are the only two UK regions with productivity above the national average. 

An extreme example is that workers in London produce 63 per cent more output per hour than workers in Wales, the least productive part of the UK. However, most influential MPs are found in the home counties.

Henry Overman, director of What Works Centre for Local Economic Growth, a research centre based at the London School of Economics, believes that higher skill levels among London’s workforce explains about two-thirds of the productivity gap between the capital and the rest of the country. 

Shamefully, British cities take up 11 places out of the 50 lowest skilled cities in Europe, if ranked by the share of workers with fewer than the equivalent of five good GCSEs. This is the importance of the Northern Powerhouse: it should not just be a good soundbite for politicians.

Generation-long failure

The Beveridge Committee in 1944 identified the need to develop Britain’s human capital by suggesting three levels of education – grammar schools for the intellectually inclined, technical colleges for those manually gifted, and secondary moderns for the remainder. Intellectual snobbery among the elites meant little was done for the manually gifted, leaving British business today dependent on continental immigration. 

Even now, prejudiced politicians are still yelping for more grammar schools, while ignoring the success of the Baker Dearing University Technical Colleges founded by former Conservative education minister Kenneth Baker. 

Yet as the FT also said, the past 10 years of almost zero interest rates and large construction firms desperate for contracts was the ideal time in which to rebuild and modernise every type of the nation’s infrastructure. 

One obstacle has been the reluctance of any government to borrow in order to finance infrastructure spending. Labour and Conservative governments have preferred partnerships with the private sector for infrastructure projects. 

Theoretically adopted in pursuit of greater efficiency, but in reality used to keep the costs off the nation’s accounts, these schemes are now widely discredited. Private finance is inevitably more expensive than public funding and there is little evidence that it has provided value for money. Not only was nothing done, but many existing contracts and plans were delayed or cancelled, all in the name of austerity and sound money. 

Prestigious projects were also pursued instead of modest cross-country rail links.

Risks of lazy thinking

The financial crisis became one of those events that enabled senior bankers and ministers to put aside all of the economics they had ever learned and fall back on what behavioural scientists call “heuristics” – practical methods not guaranteed to be optimal, but sufficient for immediate goals. 

These shortcuts to thinking have many practical advantages, but some risks, too – of which the most dangerous and least observed is the tendency to defer to existing biases. So with the nation’s finances in a potentially similar mess to that of the 1930s, the pioneering work of economist John Maynard Keynes was swiftly forgotten and Margaret Thatcher’s belief in the housewife’s budget revived. 

But, while encouraging thrift, Baroness Thatcher never forgot that national finance was not about candle ends and cheeseparing, but summoning resources to make the necessary investments for the future – in her case, the task force to the Falkland Islands. 

To expect the private sector to finance grand projects with huge construction risks and long-term pay-offs beyond most investors’ time horizon – such as Hinkley Point power station or the HS2 rail route – is a recipe for failure. Smaller projects have done well for contractors and investors alike, as Table 1 shows.

Table 1: Infrastructure investment trusts

Net asset value premiums and discounts to price (%)

Type

Now

Average

Now

Low

3i Infrastructure

16.4

16.3

23.3

12

BBGI

12.4

12.3

19.8

5.5

HICL Infrastructure

7.8

13

26

5.9

International PPP

9.7

10.2

14.2

6.1

John Laing Infrastructure

9.6

12.2

18

5.6

Peer Group

10.8

12.9

20.9

7.2

Yields and opportunities

This specialised sector of investment companies has been going long enough that investors are happy with the business concept and the yields of between 4-5 per cent a year. 

Prices have fluctuated since inception, but the trend is towards stability, with an average premium to net asset value of about 10 per cent. 

The nature of the business means that capital raising is lumpy, with equity being raised well ahead of the call for investment, so these are the best times for private investors to buy shares.

Initially all these companies bought finished projects with cash flow and returns underwritten by the government. However, as the years went by and projects diminished under austerity, the companies needed to diversify their sources of income – still guaranteed, but sometimes with more local authority involvement and better cover for future inflation. 

The biggest are 3i, HICL Infrastructure and International Public Partnerships. All companies are interesting because, theoretically at least, the government is now committed to giving local councils the freedom to initiate their own infrastructure plans – and this promises a more stable and certain flow of projects to be financed by the investment companies.

Investors concerned about yield and capital safety would do well to research their companies thoroughly, either through their own websites or that of a broker such as Numis Securities. 

There are many more ways to invest than in bonds or shares, and with governments issuing guarantees and subsidies to avoid admitting that they are investing for the health of the nation, there are plenty of imaginative managers to produce new ways for us to invest our savings.