Labour’s plan to nationalise BT's Open Reach division and roll out fibre broadband everywhere has obviously attracted controversy. But it is a logical product of financial market developments over the past 25 years – and it poses an underappreciated challenge for equity investors.
Since the mid-1990s, the cost of government borrowing has collapsed: 20-year index-linked gilt yields have fallen from 4 per cent to minus 2 per cent. The cost of equity to companies, however, has not much changed: the dividend yield on the All-Share index, at 4.2 per cent, is much as it was in 1994.
Many of you infer from this that expected returns on equities are far above those on gilts. But saying that equities are cheap and gilts are expensive is just another way of saying that the cost of capital is low for governments but high for companies.
Which is one reason (of many) why business investment has been weak for so long.
This implies that governments should take over the task of investing from the private sector – because if somebody can do a job cheaper than another man, he should get the job. Which is just what shadow chancellor John McDonnell is proposing.
This is not swivel-eyed Marxism. It’s basic economics: people should respond to incentives. It was also something advocated by Maynard Keynes, who was in many ways a free market liberal. “It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment,” he wrote in 1936, anticipating the failure of today’s loose monetary policy to raise capital spending. Full employment, he concluded, requires “a somewhat comprehensive socialisation of investment”.
Of course, things aren’t quite so simple. Markets are often better than the government at identifying investment opportunities – although this point doesn’t apply in the case of fibre broadband today. And government investment can be expensive because public sector employees have less sharp incentives to control costs: HS2 and Crossrail remind us that public sector projects can run well overbudget. However, as Said Business School’s Alexander Budzier has pointed out, cost overruns happen in the private sector too: overoptimism and difficulty in managing large projects are ubiquitous problems.
In fact, for natural monopolies such as fibre broadband, a single investor might be more efficient than the market as there will be no duplication of provision. It was for this reason that economic consultant Frontier Economics estimated last year that monopoly investment in fibre would be cheaper than a competitive system.
For equity investors, this gives us a problem. In part-nationalising BT as well as other utilities, Labour will take some big, stableish dividend payers off the market. Yes, the oil majors would be left, but with people increasingly concerned about climate change these will face increased political risk.
Sure, lots of high yielders will be left on the market. But many of these – such as miners and housebuilders – pay high yields to compensate for their cyclical risk.
Income investors therefore face the danger of having fewer and worse options.
And in nationalising some (near) monopolies Labour would leave on the market companies that do face competition. While competition is good for consumers, it is bad for shareholders because it means profits are in danger of being competed away. And because listed companies tend to be older and larger than others, they are in especial danger of being on the wrong end of creative destruction. In this sense, Labour would make the stock market a riskier place.
Investors can do two things about this. One is to look to private equity, as it might be unquoted companies that offer a chance of being genuine growth prospects. The other is to lose the fixation with income. Remember that what matters are risk-adjusted total returns.
There is, however, a paradox here. It’s often said that Labour doesn’t believe in free markets and competition. What equity investors have to fear, however, is that in taking monopolies off the market, Labour would leave equity investors more exposed to markets and competition.
