Budget Commentary

When constructing a portfolio, our main concern is the long-term robustness of the underlying investments rather than the often unpredictable nature of global geopolitical and economic events. With a long enough investment timeframe and a suitably diversified portfolio, events such as Budgets or elections rarely have a significant impact on our investment thinking. However, given the importance of this particular Budget (in terms of the potential to impact the investment landscape for UK investors) we believe it is worthy of some comment.

The attractiveness of investable assets to UK investors could have been impacted by far more than it has been by this Budget. The Chancellor did however announce the following measures:

• Rates of capital gains tax increasing from 10% to 18% for basic rate taxpayers, and from 20% to 24% for higher rate taxpayers, with immediate effect.
• Inheritance tax (IHT) relief for AIM shares has been halved from the full (100%) relief to 50% relief from April 2026.
• Inherited pensions will be subject to IHT from April 2027 (subject to a consultation).
• “Carried interest” (profits made by private equity managers) tax has increased from 28% to 32%.

All these measures were within a range of pre-Budget expectations and were by no means worst-case scenarios.

Changes to the IHT regime mentioned above, including capping full relief on qualifying Business Property Relief and Agricultural Property Relief to £1m (with 50% relief applying thereafter), require careful consideration and consultation with a good financial adviser. If you would like to speak to a financial adviser, please contact your investment manager who will be able to recommend one.
As expected, the Chancellor announced a change to the way the UK government will measure debt. By changing the measure to “public sector net financial liabilities” (from “public sector net debt”) the government will be able to borrow tens of billions more than before without breaking fiscal rules. This is an increase in the country’s debt-pile and would normally prompt investors to demand higher yields to lend to the UK government. Indeed, this was well-flagged ahead of the Budget (and caused yields to rise in recent weeks). Since the Budget, yields on UK government have modestly risen and this may be down to some concerns over other parts of the Budget.

For example, changes to so-called “non-doms” rules were worse than expected with the “non-dom” regime being abolished from April 2025 and proposals to replace this with a residency test. In addition, the government is penalising any “long-term residents” (someone resident in the UK for 10 of the last 20 years) by no longer exempting their property trusts from IHT. In short, this means living in (and paying taxes in) the UK for wealthy non-doms is now significantly less attractive. The jury is still out on whether such changes will increase the tax revenues for the UK government.

Some are also speculating that the increase in the Stamp Duty Land Tax (SDLT) via the second home surcharge (from 3% to 5%) may also have the unintended consequence of fewer property transactions, as well as reducing the attractiveness of the private rented sector for investors / landlords. It may also force landlords to increase rents to cover the extra tax burden, which in turn may especially impact those in the lower income brackets who cannot afford property ownership (surely not Labour’s intended plan).

The rise in UK government bond yields may thus reflect concern over the UK’s fiscal position and / or higher inflation expectations (and the resultant and probable slower pace of interest rate cuts; prior to the Budget futures markets had priced in two 0.25% cuts before the end of the year). Indeed, in their Economic and Fiscal Outlook released in the wake of the Budget the Office for Budget Responsibility (OBR) called this “one of the largest fiscal loosenings of any fiscal event in recent decades”. They state that the Budget increases overall spending by almost £70bn a year over the next five years, with £32bn of this funded by an increase in government borrowing. The 1.2% increase in employers’ national (76% of which the OBR estimates will be passed through to workers via lower wages) raises £25bn and the non-dom measures aim to bring in £12.7bn a year with other measures bringing in the balance.

All that being said, yields on the debt of other European nations rose on the day, and yields on UK government debt across the curve are still lower than a year ago.

Investment Implications

News of the IHT relief for the AIM market was clearly a better-than-worst case scenario and it rallied immediately after the Budget, closing the day some 4% higher. AIM shares in aggregate have long underperformed other UK listed shares (due to speculation about the full removal of IHT relief), and much of this market is very cheap indeed. The AIM market is not just a means for investors to avoid IHT. It is home to very cheap shares and high-quality businesses that highly talented UK small cap fund managers invest in, including our own highly talented and top-performing AIM specialist, Ian Woolley. The removal of the uncertainty around IHT relief may finally persuade greater investment into AIM from all kinds of investors – to the benefit of all investors in UK equities. Our existing AIM clients will be receiving a letter from their Investment Manager over the next few days. For anyone interested in our AIM services, please contact Ian Woolley, Head of AIM Services.

As discussed, government bond yields are marginally higher (i.e. prices lower) having fallen (prices higher) when the Chancellor first started speaking. This also has a knock-on impact to the investment trust sector, and especially to those trusts that own assets with revenues linked to long-term contracts (e.g. property and infrastructure). Higher government bond yields make these assets, all other things being equal, less attractive. At the time of writing these trusts are little changed from yesterday morning.

And from George Salmon, our Senior Research Analyst:

“Raising employer NI brings more costs to UK corporates. That’s not a change that will be welcomed by finance directors. But let’s not forget that far bigger increases came during the recent inflationary cycle. The best businesses weathered that shock and emerged stronger, and we believe they can keep creating value for investors in the years to come.

The government is frantically trying to plug what they are characterising as a multi-billion black hole and is overshadowed by a debt mountain running into the trillions, while the oil and gas majors and tobacco companies have seen profits increase in recent years. That combination means new measures on these sectors, which are perennially seen as piñatas to bash some bounty from, are not surprising. Notably though, Labour resisted tapping into the gambling sector, sending names across the space up in a relief rally.

Elsewhere, the defence budget is being increased, and this will likely only add to the bulging order books in the sector. Infrastructure budgets have also been uplifted, and there will be hopes that this spend supports the construction groups. But with structurally low margins and a track record of volatility, we’re wary of being suckered into thinking this represents a new era of robust returns. The housebuilders are hopefully also able to capitalise on the building boom Labour is trying to ignite. Plans to build 1.5m new homes this parliament have been turning heads, and there was more investment in the sector today. Realistically though, whether we get fireworks or not over this parliament depends to a large degree on the direction of interest rates. A reluctance by the Bank to cut as quickly as is currently hoped could pour cold water on that particular bonfire.”

Conclusion

Before the election, having read the Labour Party’s “Financing Growth” document, the hopes of investors in the UK market were high. As we sit here today, it is fair to say the combination of the first months of the new Labour government and this Budget have left us underwhelmed. Having said that, having read some of the seemingly interminable pre-Budget speculation, the Budget could have been far worse. Happily, uncertainty around the content of the Budget has now been removed and that alone is positive.

The fact remains that vast swathes of the UK equity market (especially smaller companies) remain very cheap. With the Budget-uncertainty out of the way, we may see a return of investors to UK equity markets. If that doesn’t happen, and shares remain cheap, they will be vulnerable to takeovers from foreign businesses or private equity buyers. Value is usually realised in the end.

Ben Conway – Chief Investment Officer

George Salmon – Senior Research Analyst

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