Set up as a soft target

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The Independent Online
The latest fashionable subject for discussion round City dining tables is patient money. The idea is that pension funds and other large investors should hold shares for far longer than they do now.

Put another way, pension funds are being accused of churning. They move billions of pounds around, buying and selling shares, without any obvious benefit to anyone except stockbrokers, who earn a commission on deals.

Pensioners do not get anything out of it, as the dealing costs offset any benefit to performance. (More precisely, there is no correlation between activity rates and investment returns, according to Combined Actuarial Performance Services). This makes all this wheeling and dealing hard to justify.

Companies find it unsettling and fear it makes them vulnerable to takeover. Directors want their shareholders to stick with them through thick and thin.

As with the vexed subject of corporate governance, the plan is to draw up a code. Whether it will have any more effect than Sir Adrian Cadbury's effort remains to be seen.

The concept has been welcomed by Paul Myners of Gartmore Investment, which produced the best performance of the large fund management firms last year, but the draft code needs a lot of work. It was drawn up by Sciteb, a consultancy that recently drew together leading figures from the City and industry to discuss disclosure and related issues. They included Lord Tombs of Rolls-Royce and Sir Anthony Gill of Lucas and, from the Square Mile, David Rough of Legal & General and Janet Sidaway of Kleinwort Benson.

In its current form the code is unlikely to attract much support. For example, it suggests that trustees should instruct investment managers to keep shares for five years and hold shares in only 20 to 40 companies.

No fund manager would accept these conditions, especially if they accompanied the standard brief of outperforming the average. The aims almost certainly conflict.

But concern about churning is, if anything, set to increase. Pension funds hold shares in UK companies for less than four years on average, which means some fund managers hold them for very short periods indeed.

Of course averages mask a huge range of behaviour. As one fund manager said: 'Is it short-termist to sell a stock to a bidder if you have held it for 10 years?'

UK companies should, however, consider themselves lucky. The pension fund managers are even less loyal to overseas companies - they hold their shares for less than eight months on average.

Why the difference? Phillips & Drew Fund Management, which has monitored activity rates for several years, reckons it is to do with stamp duty. In the UK this transaction tax is levied at 0.5 per cent of the value of each deal whereas there is no stamp duty payable on overseas share deals.

The Government promised to remove stamp duty when Taurus, the Stock Exchange system that would have replaced share certificates with electronic records, was introduced. Now that Taurus has been dropped, the Government is expected to remove it once Pen Kent's Bank of England committee has come up with a replacement.

Experience suggests that activity rates will surge when stamp duty - which raises about pounds 1bn a year - goes. Its halving was behind the ballooning volumes of share dealings - and declining holding periods - in the Eighties.

Not only companies anxious about the stability of their shareholder registers are concerned by this prospect. The Government would like to recoup as much of the revenue currently raised from stamp duty as it can, given the parlous state of public finances.

One idea that might meet the needs of the Treasury, companies and pensioners, though not stockbrokers, would be for the Government to introduce a capital gains tax on shares sold by pension funds after, say, only four years. It would be a turnover tax.

In theory at least, pension funds are already taxable on gains made through 'trading' rather than 'investment' but no one has ever defined what is meant by trading. So the measure could - at a stretch - be presented as merely tinkering with existing rules.

It would be deeply unpopular with pension funds, already smarting under the blow of the last Budget, which hit them for an initial pounds 800m. Trustees and others are worried that tax changes are helping to erode surpluses. But at least it could be presented as a long-termist measure.

Pension funds would, however, have only themselves to blame. They accepted the recent Budget change to the way dividends are taxed with hardly any complaint, making them a far softer target than the Government had any right to expect.

The National Association of Pension Funds has written to 60 MPs, to Peter Lilley, the Secretary of State for Social Services, and to Norman Lamont, the Chancellor, to register its protest. But this response hardly registers on the Richter scale.

By accepting the dividend change so meekly, pension funds have laid themselves open to further attack. Perhaps they reckoned that the days of their privileged tax status were numbered anyway so it was no use protesting.

They may yet regret this stance.