The ongoing talks about Theresa May’s Brexit Deal regularly bring up the links that the United Kingdom has with other countries, inside and out of the EU. Most of these conversations focus on trade, but what if we were to redirect the analysis to financial investment instead?
The Office for National Statistics has produced a large dataset to analyse the investment relationship that the UK has with countries in the world (dating back to 1999).
In the context of the data, they have included where foreign companies acquire a UK company, whether a fund manager invests into foreign assets, or even whether you or any other person has set up an account with a non UK bank.
Investments such as these usually have the aim of diversifying portfolios, increasing market share or entering new markets, or simply to make the most of the return offered by the foreign entity.
The data collected by the ONS shows that we do not have a foreign investment deficit, or even surplus, with the total stock of UK investments abroad reaching £11tn, matched by the similar amount of foreign investment in the UK.
To put that £11tn into a context, the GDP of the entire United Kingdom was £2tn, which meant that the GDP of the 5th largest country in the world was less than one fifth of the value of UK investments abroad, and foreign investment in the UK. Only the United States had a larger GDP than this investment!
Furthermore, the GDP of the United Kingdom is comparable to France, but the level of UK investments was almost double (France having £5.9tn in 2017).
Why Do We Have a Large Foreign Investment Account?
Well the value of foreign investment is still not as large as in 2008 before the Financial Crisis, but recent events have increased it relatively quickly.
The Brexit Referendum in 2016 was one of the main reasons why the investment increased by £800bn.
Other than the new investments which totaled £150bn, the Pound depreciated significantly after the vote to ‘leave’ which increased the value of the mostly denominated foreign currency held in UK banks.
Which Countries are Most Invested in the UK?
From the UK’s perspective, over 30% of our total investment is in the United States. Second in the list is France with 9%, then Germany, the Netherlands, Japan and Luxembourg (7%, 6%, 5% and 3% respectively).
When looking the other way, the US reciprocates the preference, being our largest investor.
The rankings may change after Brexit though, as Theresa May has mentioned her plans for increased investment in Africa, probably because of the need to increase trade around the world (not just with the EU).
The shift to Africa has already been seen in the data, as the total investment in Africa has risen by around 60% since the financial crisis, while to contrast, the investment in Europe has fallen 20% in that time.
Despite the increase in investment in Africa, and the decrease in the European Union, the total investment in the EU is still almost 40 times the size of the investment in Africa.
The current investment in Africa is by no means small, despite no African countries not featuring in the top ten.
While UK investment in Africa has risen by 61% since 2008, investment in Europe has dropped by 20% in the same period.
Yet UK investment in Europe was worth approximately 38 times as much as investment in Africa in 2017.
Despite the small absolute investment, it is unlikely that the investors are going to pull out any time soon.
This is shown by the type of investments; 54% of investment in Africa by the UK is either direct or by portfolio (direct is a > 10% holding in a company, vs. portfolio which is a < 10% holding).
These investments are usually made for long term returns as they are not as liquid as other investments (such as loans and deposits in banks). For a comparison, just 39% of investments in the EU are either direct or for portfolios.
One of the difficulties in measuring the investment from abroad into the UK, is finding where the funds originated from.
It is not uncommon for an investor to use a subsidiary to invest on their behalf, and the location of the investor and the subsidiary can be different.
This extra degree of separation can skew the results depending on which way you want to view the data.
There are two ways to analyse foreign investment; either by the immediate investor (either a primary or secondary investor), or an ultimate investor (always primary).
The statistics presented here just show the investment into the UK by immediate investor, which is why the Netherlands and Luxembourg rank so highly, but after the previous analysis by the ONS which looked into the ultimate investor, it was clear that investments were made through these two countries from investors who didn’t reside there.
If we use the ultimate investor in this analysis, then the investment into the UK from the EU was 17% lower than in 2016 (probably due to Brexit), as opposed to an increase of 33% from the US.
Why do People Invest Abroad?
The first expectation that comes to mind is that the rate of return is perhaps higher in certain countries, and that would lead to investors moving their money from the countries with the lowest returns.
In reality, the data shows no such relationship. The United States has the largest investments, and one of the lowest rate of returns, while the last two spots in our top ten (Hong Kong and Australia) have twice the rate of return of the United States, but less than 10% of the investment that the United States has.
The next logical thought is that perhaps investors are not willing to take the risk that comes with higher rate of returns, and instead invest in the lower rate for a more confident investment.
The trade-off between risk and return, and the difficult to assess risk aversion mean that we cannot say with confidence why one country has more investment than another when considering these two factors.
Other than these two offsetting factors, the one factor that we do have confidence in (when giving a reason for the levels of investment), is the local tax law. The sixth largest country for UK investment is Ireland, which is attractive by way of having some of the lowest rates of corporation tax in Europe (currently 12.5%).
Whether Britain leaves the EU, or has another referendum and ends up staying, it will be interesting to follow the composition of foreign investment in the UK going forward.