Buyback boom

Long stories short

• Carl Icahn admitted losing $9 billion betting on a 2017 market collapse.
• Sunak said he was in talks with the EU to keep carmakers in Britain.
• Russia said its economy contracted by nearly 2 per cent in the first quarter.

Buyback boom

Share buybacks are more and more popular with boards, and less and less with politicians. Biden has taxed them and wants to tax them more. Macron wants to find a way to funnel more profits to workers. The UK is on the fence, but its pension funds are not: they’re bidding old-fashioned dividends a long farewell in favour of buybacks and bonds. 

So what? There are good arguments for and against buybacks (see below) but as they grow in popularity in the UK, ministers should worry that

• they’re weakening the link between mum-and-dad investors and the big privatised companies that gave capitalism a good name under Thatcher; and 
• in doing so they’re widening the gap between UK pension funds and the British utilities and infrastructure stocks that used to sustain them. 

The great self-licking popsicle. Buybacks are a mechanism for companies to hand surplus cash to shareholders and at the same time gain market value, at least on paper. A company buys its own shares and then cancels them, which juices the remaining shares. Dividends release money that firms don’t get back.

Broadly, buybacks benefit institutions, traders and the rich. Dividends can benefit the rest of us. 

By the numbers:

$6.31 billion – value of buybacks announced so far this year by Shell, BP, Burberry, Apple and Alphabet combined

$1.3 trillion – total value of buybacks announced last year by the world’s 1,200 biggest companies

3 – factor by which buyback volumes grew in the decade to 2022

1.5 – factor by which dividends grew in the same period

4 – factor by which oil majors’ buybacks grew in 2021 alone

Are they bad? Depends on whom you ask. Critics say

• they give only a short-lived boost to share prices;
• they’re a cynical ploy to inflate the value of share-based compensation plans; and
• companies would be better off investing spare cash to grow.

Advocates say buybacks

• stop executives wasting money on ill-judged acquisitions; 
• create long-term value by giving shareholders a bigger stake in the company; and
• are a great tax dodge, because income tax on dividends is paid at a higher rate than capital gains tax on investment gains generated by buybacks.

Made in America? Yes, but they’re crossing the Atlantic. Last year, UK companies spent $71 billion on buybacks and $89 billion on dividends, meaning buybacks accounted for about 44 per cent of shareholder payouts — by far the largest proportion for any year in the decade to 2022, a Tortoise analysis of Janus Henderson data found. 

Meanwhile on Bond Street. Wherever you stand in the buybacks v dividends debate, pension funds and thus holders are missing out on some of these payouts as they diversify, especially into long-term bonds.

A little history. In the UK, pension contributions are exempt from income tax, and investment gains made by pension funds aren’t subject to capital gains tax. This is great news for pension fund managers because they end up with bigger pots of money on which to charge fees.

In return for favourable tax treatment UK pension funds used to invest heavily in UK companies. In 1997, they invested 53 per cent of their money in domestic companies, research by the New Financial think tank shows. And they benefited handsomely from dividend payouts and buybacks alike.

But that symbiosis didn’t last.

• Pension undertakings were too generous (think final-salary schemes).
• Funds underestimated how long baby boomers would live.
• So they sold shares to buy bonds: safe, long-term investments that secured the pension pots of the post-war generation. And when pension funds did buy shares, they saw more exciting prospects abroad, like fast-growing China and a booming Silicon Valley.

By 2021, UK pension fund investments in domestic companies stood at just 6 per cent.

Tell Sid. British retail investors fell out of love with share ownership in the decades after the Thatcher years, leaving pension funds as the glue binding the public to the stock market. The funds invested money in domestic companies, these companies paid pension money into the funds, and the circle was virtuous.

The post-financial crisis shift from shares to bonds has burned away the glue. UK pension funds missing out on buyback and dividend wealth is part of the story of a deepening divide between the British public and shareholder capitalism.

Ministers wanting to reverse the trend could force domestic pension funds to buy back into UK companies. One lever would be restricting the capital gains tax exemption to funds that invest a certain minimum percentage of their money in UK shares.

But for now, that’s think tank policymaking, not manifesto material.