Capital Flows and Asset Markets

As explained in a post from a year ago - there are three profit centres to short selling. Capital gains, carry and currency.

Capital gains is the easiest to understand, and strangely the least profitable of the three centres. Why least profitable? In my experience crowded shorts tend to visit huge losses on short sellers. GME and AMC are recent examples, but for many years Tesla was the biggest short in the market. These shorts suffered significant capital losses. As a rule, I avoided crowded shorts, which I define as a short with a borrow cost over 2%. For much of the period from 2010 to 2019, the borrow cost was well above 2%, so shorts in Tesla suffered from carry costs as well as huge capital losses.

Short selling disasters like Tesla has virtually destroyed the short selling community of hedge funds. HFRI used to publish a short bias index, but discontinued some time ago. Barclays also had a short bias index, also discontinued. It is the green line below, the grey line is the S&P 500 and the blue line is the Barclays CTA index. 2008 was the hey day for short selling, and its been miserable ever since.

Another way to see this is the collapse in short selling in the US market. Unfortunately there is not a single data source we can use, but we can splice together two similar data sources to see that short selling is at close to historical lows.

The cause of the destruction of the short bias hedge fund is not hard to find. From 1980 through to 2007, the Fed Fund rate was above the dividend yield of the S&P 500. Which meant that as long as short borrow cost for shorting was low, you could earn carry on short selling. Carry is the interest you earn on the cash you raise from short selling. When you short sell, you borrow shares from a long term holder for a fee. You sell the shares in the market, and receive cash. the interest you earn on that cash is called carry. From 2008 until 2022, the Fed fund rate was below the S&P 500 dividend yield, meaning that short selling had a negative carry. As most short sellers do not make any capital gains (see Tesla, GME or AMC), without carry, their funds could not generate any returns.

You might be saying to yourself, I am sure Russell was net short from 2011 through to 2020, why could he make money, when all other short funds imploded. Well I used to exploit one recurring feature of the pro-capital era - currency devaluations. Currency is the third profit centre of short selling. When profits and credit quality comes under pressure, most countries chose devaluation to restore profits and export competitiveness at the expense of workers. The key to profiting from currency devaluation was to make sure you shorted an exporter to devaluating nation that would have a strong currency. Devaluation is explicitly exporting your problems to your trade partners. From 2010 to 2016, there was good money in exploiting the mispricing of currency risk in equities. The key was to be short in a “hard currency” - such as USD, Euro or even Yen. The US dollar line of Brazilian Banks was an example of this.

As we move back to a pro-labour world, the implication is that currency as profit centre will be limited. In a pro-labour world, governments try to keep the currency strong to keep wage growth strong. This implies tighter monetary policy, which is what we have seen. With S&P 500 dividend yield at close to all time lows, and the Fed Fund Rate at 5.5%, the carry trade and the opportunity for some capital gains makes short selling look attractive to me again.

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One of the first things I learnt when I started in the fund management industry was that Japanese banks were where value investors went to die. After a huge bull market in the 1980s, that made Japanese banks the most valuable in the world, a long drawn out bear market has ensued. Having been involved in the 2003 to 2006 bull market in Japanese banks, I have a profound respect for their ability to indicate deflationary turns in markets.

The most obvious reason for the recent performance of Japanese banks has been rising JGB yields. The rally in Japanese banks from 2003 to 2006, petered out when JGB yields stopped rising, but that has not happened yet in this case.

Japanese banks are not as cheap as they were. For me, lending is easy, taking in and keeping deposits is hard (looking at you Silicon Valley Bank!). So I tend to look at market cap to deposits as a measure of cheapness. Japanese banks come in at a market cap of 4% of deposits. On that metric Chinese, Korean and French banks are similar at 5%, while the US is now at 12%, down from 20% not long ago. Should I buy all the cheap banks? Well there is one big difference between Japan and everywhere else.

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When I first outlined my view on a shift to a pro-labour world, I saw private equity as a structural short. One of my favourites places to short were companies recently listed by private equity firms. They were almost always starved of capital investment, and typically laden with debt. I saw the rise of interest rates, pressure on capital markets and reduced exits as kryptonite to these businesses. While they were weak in 2022, like broader markets, they have bounced in 2023.

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Back when I was managing money, I was told that my fund was described as a macro fun that uses single stocks to express an opinion. Macro funds tend to use stock indices, bond and commodity futures to express views, but I found it more efficient to use single stocks. Indices are designed to go up, and can never go to zero, so are an inefficient product for bearish bets. Individual stocks can go to zero, so are far better for bearish views. This led me to think a far more efficient hedge fund model would be be long stock indices, and then to short individual stocks against it, while in practice most hedge funds do the opposite. This is why I think long short hedge funds have been so poor since 2008, if not before. Macro funds are probably looking bad again as the S&P 500 is breaking away from its old relationship with job openings (hat tip to Michael Hartnett at BOA for this chart).

Having been caught out by going bearish in 2016 and in 2019, when it looked like the US economy was slowing, I have learnt the hard way we are no longer in a “macro market” but a political one, at least at the top end. My top short remains TLT, which continues to draw capital even as it incinerates it.

But 2023 has certainly been a year where the strategy of long S&P 500 future, and short single stocks names would have been very good. Let’s look at one short themes that have worked, and how much juice this theme might have left in it. (This is a paid post, but I am offering a 7 day trial if you subscribe to www.jarrettclarkracing.com - another substack I write about my son’s karting career)

I have written a number of posts about the enormous profits of US tech companies, and how they are comparable to profits of the East India Company. The implication was that at some point, there would be an “anti-Empire” movement, that would directly attack the structure of these companies. On the surface of it, it is very easy to compare Pax Americana to the British Empire. At its peak, the British Empire ran through large chunks of the America, Africa, Asia and Oceania.

Comparing the British Empire to the reach of the US military today, shows a similar type of dominance. If anything US influence is concentrated in rich countries, rather than developing countries.

Does the rise and potential fall of a “US Empire” lead to any tradable ides? Well following this line of thinking does yield some interesting analysis, namely on FTC anti-monopoly actions, and on tax policy of the US and Ireland. And both areas are certainly areas I would keep an eye on as change is potentially coming. However, the problem with this analysis was that the decline of the British Empire could be directly traced through British lost of control as various countries gained their independence. It is very hard to find an equivalent feature in current global politics. However, a few months ago, the Economist recommended “After Tamerlane - The Rise & Fall of Global Empires, 1400 -2000” by John Darwin as an interesting book on the idea of empire. The first chapter is incredible in its iconoclastic thinking of empire. And I have been taking in those ideas, and trying to apply them to the world we see today.

As we are talking from 1400s to to today, we are only looking at the Eurasian megacontinent - stretching from the British Isles to Indonesia and from Russian to North Africa. Within this Eurasian mega continent, there are three different empires, competiting for power and influence. They are European, Islam and China. Or alternatively, you could call these Empires, Christian, Islamic and Confucian. The point here is that these empires used religion to define and sustain them. From this perspective, the schisms between Protestant and Catholics was/is a battle for control of the “Christian empire”, likewise the schism between Sunnis and Shias was/is a battle for control of the Islamic empire. The Chinese centred Confucian empire included East Asia (Japan and Korea). Until the rise of the Americas as extensions of the European empire, Islam was probably the dominant Empire. Stretching through all of North Africa, Southern Russia, India, and South East Asia. The Christian Empire stretched from Western Europe through Russia. And the Confucian empire included China, Korea, Japan as well as deeply influential on Indochina. With these observations, all major conflicts can be identified as one two types. A battles between empires, or a battle within empires.

So, what does this mean for modern Empire and geopolitics? So first, we need to reinterpret 20th century history through this lens of Empire. For most of the post World War II period, the Cold War dominated geopolitics. USSR vs the Free World. Using this new thinking, the Cold War was about American and USSR fighting for control of the European empire. And Communism, with its anti-Imperialism and anti-religion ideas was able to pick up various non-European allies such as China and India. The European Empire dominated the world in the post World War II period. Japan has allied with the West to try and continue to dominate the Confucian empire, and keep China at bay. That is Japan is not within a Christian or European empire, but aligned with the Europeans to dominate the Confucian empire. Russia has aligned itself with China, to try and build greater influence within a European empire.

Continuing this analysis further, countries that are relatively religiously homogenous are likely to be stable. Most of Russia is religiously homogenous, and stable, except for the Muslim majority region, Chechnya. Other nations and regions where the borders of this large empires clash internally would include, Malaysia, Nigeria, The Balkans, Myanmar, Cameroon among others.

Using this analysis, we can explain much of the politics we now find on the right. For decades, the dominance of European empire was unchallenged, with both China and the Middle East locked internal power struggles. However, as China resolved its internal struggle, it has grown more and more powerful. The rise of China has led to the old fissures of Empire to be reopened. For me, it explains why the rise of China has seemingly also opened up a more profound nationalist and religious aspect to politics. How does fear of rising China, lead to bans on veils and and trying to reduce Muslim immigration? They should seemingly be unconnected, but in fact it is the return of old empirical politics.

The rise of China has led the European/Christian empire to ally itself with India. For centuries, India was under Islamic rule, and influence. India was ruled by the Mughals for over 300 years, and when you included Pakistan and Bangladesh populations back into a Raj India, Muslims made up over third the total population. Under Modi, India is carving out a new Hindu empire. Or in other words, political and religious power are becoming intertwined, as they are in the other great empires. The implication is that in 20 years we will have a 4 way geo-political battle between European, Islamic, Confucian and Hindu world. The signs of this new Hindu empire being in conflict with the rest of the world is already undeniably apparent. Border clashes with Pakistan, and China are part of this. So is the recent assassination of a Sikh leader in Canada. But with 20% of India’s population still Muslim, there is no question that some sort of severe political event in India is coming.

What does this mean? Globalisation and capitalism both had at its core a globalised consumer, where nationality and religion were not important. Consumerism was the global religion. No longer. Nationalism and religion are going to become more important. And for the first time in history, the idea of a Hindu empire, and all that means will be a huge factor in geo-politics. To make an analogy, religion are the geopolitical tectonic plates of the world. They can be dormant for long periods, but when this plates begin to more, political earthquakes ensue. India, sits at the heart of a new tectonic plate, expect a geo-political earthquake at some point.

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Has the Federal Reserve fucked up? Markets were a bit unsure of what the decisions would be from the Federal Reserve. Looking at monetary policy history, they would have seemed wise to pause interest rates increases. Looking at the US bond market, with it deeply inverted, this has typically been seen as a sign of “over-tightening” by the Federal Reserve. The 2 year to 10 year spread is its most negative since the 1970s, and previous bouts of yield inversion have preceded financial problems.

And if you look around, there are loads of indicators that show the economy is beginning to roll over. (Become a paid subscriber here, or subscribe to www.jarrettclarkracing.com for a 7 day free trial to keep reading)

This week’s Economist has a leader, criticising America’s new drug-pricing rules. I knew this was going to be a subpar article when the first line is “A quirk of American law long barred Medicare, the public-health insurer for the elderly, from negotiating with drug firms over prices.” To describe this as a quirk is a stretch. It is almost certainly the product of lobbying buy US drug companies, and at odds with the VA prescription system, also state funded, which is allowed to negotiate drug prices on behalf of its members.

Back in 2017, I published a note on the US healthcare system, explaining how exactly Medicare had come to be abused by many of the drug companies now complaining. I republish it now, as I am working on updating it, and having the old note on the website will be helpful, when I finish the update. I generally don’t like reposts, but this one is useful.

The US Healthcare system is truly extraordinary.  Per capita spending on healthcare is double the levels seen in most other developed countries.  This is in part driven by a very different set up.  Key differences are the private sector has far more freedom to market drugs directly to consumers, and Medicare, the largest buyer of drugs, is prohibited by law from negotiating lower prices.  The result is that the US has higher prices for drugs, and due to the extra spend, also has the most innovative drug market.  It can be argued that the US subsidises drug development for the rest of the world.  However, recent increases in drug prices seem to have been driven by regulatory changes due to the Affordable Care Act (Obamacare), rather than market forces. 

In 2016, total US health expenditures were USD 3.3 trillion.  US citizens directly paid (out of pocket) for USD 350bn, with the remainder paid by third parties.  USD 1.1 trillion was paid for by private health insurance, with Medicare and Medicaid paying USD 1.2 trillion.  Finally, USD528 billion was met by a mixture of other government programs, privately raised funds and charities.     

Of the total USD 3.3 trillion spent on healthcare, USD600 bn was spent on drugs, with half on prescription drugs.  The other half was spent on drugs used in procedures, and not procured via a prescription. While drug spending has doubled since 2007, we have seen a steady increase in the use of generics at the expense of branded drugs. 

However, even as we have seen volumes decline for branded drugs, we have seen an increase in total spend for branded drugs. 

Generic drug spend has also increased significantly in the last few years.  Both generic and branded drugs have seen price increases. 

The above graphs, would imply that all prescription drugs, both branded and generics have seen price increases.  However when we consult data from independent US advisory agency, MEDpac and from the Centre of Medicare and Medicaid Studies (CMS) a different picture appears. 

MEDpac looks at Medicare Part D (the part of Medicare that pays for prescription drugs) data from 2009 to 2014.  The most striking feature is how the average price for a prescription for a low cost beneficiary has fallen by 24% over the period, while the average drug cost for high cost beneficiaries has risen by 50% over the same period. 

One of the reasons for the increase in high cost beneficiaries has been the development of a new drugs that cure hepatitis C.  The main drugs used here are Solvadi and Harvoni, and according to data from CMS, total Medicare spending on these drugs in 2014 was 3.8bn USD from nothing in 2009.  Total high cost spending without the hepatitis C drugs would have still risen to 60.8bn USD, or a doubling of spending on high cost drugs compared to a 27% rise on low cost drugs.  Excluding the hepatitis drugs, we can see that drug spend rose 14% for Medicare in 2015 from 2014, while it rose 25% for Medicaid over the same period.    Given that volumes have been flat, and we have excluded the big increase from hepatitis C drugs, the growth in spending has been driven by drug prices. 

Drug cost increases at Medicare and Medicaid have been driven by long standing issues, that were exacerbated by the changes brought about by Obamacare.  Government run pharmaceutical plans such as Medicare and Medicaid are banned from negotiating drug prices with manufacturers.  This is at odds with other government run healthcare programs such as the UK’s NHS, which use their buying power to drive prices down.   

There are two big drivers to recent drug increases in my view.  There has been changes in how Medicare pays for drugs, creating an incentive for drug companies to raise prices.  The second has been the increase in the number of orphan drugs being developed, which has put upward pressure on drug prices.  Both factors now look to be coming under regulatory pressure. 

For Medicare Part D spending, high cost beneficiaries are defined as those beneficiaries who spend over USD6154 a year on drugs.  Spending in excess of USD6154 is 95% covered by Medicare.  However spending from USD2700 to USD6154 is not covered at all by Medicare.  Spending from USD 295 to 2700 is 75% covered by Medicare, while the first USD 295 is not covered at all by Medicare.  The gap from USD 2700 to USD 6154 is known as the Medicare Donut Hole.  Changes under Affordable Care Act, allowed for some drugs to be purchased at a 50% discount to list price, while the full list price could be counted towards Medicare Donut Hole.  Below graph shows the out of pocket spending for a given level of drug spending. 

For drugs with little or no competition, prices could be raised without effecting demand, as the drug consumer would potentially see marginal prices fall dramatically if this pushed them in to the top tier of Medicare benefits where costs are 95% covered.  This can be most clearly seen in the graph below where out of pocket spending on drugs fell even as health insurance spending on drugs rose.    According to the Medicare (a federally run health program for the old) drug spending dashboard, 29 of the 70 drugs details saw 50% price increase over 5 years.  Medicaid (state run health program that targets the poor) saw ever larger number of drugs with big price increases. 

The FDA is starting to take aim at rising drug prices, particular older drugs that have recently seen drug prices increase by speeding up the approval of generic drugs https://www.fda.gov/newsevents/newsroom/pressannouncements/ucm564725.htm 

This has a detrimental effect on the share prices of generic drug makers, as increasing competition is being priced in. 

Orphan drugs, are drugs that are designed for conditions with relatively small numbers of sufferers.  In the US this is defined as having less than 200,000 potential patients.  If orphan drug status is granted by the FDA, then 7 years marketing exclusivity is given as well as 50% tax credit on R&D, plus other grants.  The rising share of orphan drugs has also been a big driver of higher costs.  According to the EvaluatePharma Orphan Drug report 2017, the average cost per patient of orphan drugs is USD 140,000 vs USD 28,000 for non-orphan drugs.  The same report notes that orphan drug sales now make up nearly 20% of all drugs sales worldwide, up from 11% in 2008. 

There is an issue with the Orphan Drug Act, as highlighted by this blog post from the relatively new head of the FDA, Scott Gottlieb.  See here. (Note Scott Gottlieb stepped down as FDA head in April 2019) The post states that Orphan Drug status has been granted for many paediatric treatments.  There were pre-existing laws that were intended to stimulate paediatric drug studies.  However, the use of paediatric sub-groups to gain orphan status has actually led to less paediatric studies.  This would imply that the FDA is looking to greatly tighten up the issuance of Orphan Drug status.  Orphan Drug status has conveyed great benefits on the pharmaceutical industry.  Firstly, it allows drugs to be tested on smaller populations, greatly reducing costs.  Secondly, it has allowed some drugs to be granted orphan drug status, but then go on to be used for treatment of much wider patient population.  Thirdly, some large pharmaceutical companies have sought and received orphan drug status for the some of the best-selling drugs in the world.  These highly profitable drugs, then received favourable tax credits and exclusivity on marketing in this area for 7 years.  The Kaiser Health Network found that about a third of orphan drug approvals have either been repurposed for all users or have received multiple orphan drug status to market so different subsets of patients.  

Rising drug costs have been one cause of rising insurance premiums in the US, which have risen faster than income and inflation over the last 10 years.  The new head of the FDA is looking to foster competition to reverse these effects, and his efforts have already lead to weakness in generic pharmaceutical companies. Investors should exercise caution with branded pharmaceutical companies. 

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Aston Martin is an iconic car brand. It has been James Bond’s choice of car since the 1960s. It is a brand that could be compared to Porsche, Ferrari and other premium car marques. The problem is that the brand has not been managed as well as these other brands. Aston Martin the company can been generally loss making since 2011. Initial investors in its 2018 IPO have lost over 90% of their capital. Over this time their have been multiple rights issues, which has seen shares outstanding rise from 95 million shares to over 700 million shares today. This leaves Aston Martin with a market capitalisation of GBP 2.7bn (USD 3.4bn).

The investment opportunity in Aston Martin is pretty obvious. Take its heritage and brand and make it more like Ferrari. The contrast in share prices is striking. Ferrari share price is at all time highs, and worth a cool USD 55bn. On a valuation basis, Aston Martin is 2 times sales to market cap, while Ferrari is closer to 10.

The problem with the idea of making Aston Martin more like Ferrari, was that you needed an investor with the long term patience of the Ferrari family to build brand value, something that had been lacking at Aston Martin. Enter Lawrence Stroll - who began building a stake in Aston Martin in 2020. He also greatly increased his investment in 2022 at very low prices, and with a big rally in the share price in 2023, he might be making money on this investment. However, Lawrence Stroll is not just investing with a view to turning Aston Martin into the next Ferrari. He has been involved in F1 since 2017 to get his son, Lance Stroll, a drive. This has included a reputed USD80m payment to Williams for his first drive in F1 in 2017, and then the purchase of failed F1 team, Force India rebranded to Racing Point, for another USD 100m. Racing Point was folded into Aston Martin, so it actually not very clear to me how much money Lawrence Stroll has invested in F1, but lets say somewhere between USD 500m to USD 1bn. For investors in Aston Martin, here is the unknowable question - is Lawrence Stroll trying to build a new Ferrari, or is he trying to buy a drivers championship for his son?

There are two main championships you compete for in F1, the driver’s championship and the manufacturer’s championship. Without question, money can buy you a manufacturing championship. In 2005, Red Bull, a company with no previous car manufacturing experience entered Formula 1. For them an F1 team, which costs at least US 300m to run annually was seen as a marketing spend. The idea was to extend the Red Bull brand from nightclubs and truck drivers, to health and sport. Although Red Bull entered F1 as a marketing ploy, the team is intensely focused on winning. Underperforming drivers are replaced, and ruthless tactics are used when necessary. Red Bull has shown that with enough money, you can buy a F1 manufacturing championship. Ferrari has also historically been ruthless with drivers. For both teams, the brand is bigger than the drivers.

Lawrence Stroll has bought a controlling stake in Aston Martin, the business idea is turn it to a luxury auto brand like Ferrari. For this, he needs success in Formula 1, and to achieve that has paid up to get the services of two former world champions, first Sebastian Vettel, and now Fernando Alonso. Technical improvements have improved Aston Martin phenomenally, to a degree that Alonso is on track this season to score the most points since 2013. Currently, he is 3rd in the standings behind the two Red Bull drivers. Despite Alonso’s success, Aston Martin is only 4th in manufacturers championship. Why? Well the Aston Martin team is keeping faith with the long serving driver, Lance Stroll.

As a karting parent (see www.jarrettclarkracing.com for more details), I can put myself in Lawrence Stroll’s shoes (although sadly, not spend that much money). He paid to get his son a drive and experience in F1 with Williams, but with an underpowered car that has no chance of winning. He then bought a failing team, and did a deal with Mercedes to get it a good engine. He has then bought a famous brand, and brought in top drivers who are near retirement, to act as mentors as well as bring prestige to the brand such as Vettel and Alonso. Despite all this, the chances of Lance Stroll winning a driver’s championship is remote. His big problem, and the same problem all karting parents face when you try and buy wins, is eventually you will come up against someone with as much or more money as you. While Lawrence is worth a USD 4 billion, Mark Mateshcitz, who controls 49% of Red Bull is worth USD 52 billion. Ferrari with a market cap of USD 55 billion would all have the financial resources to stop anyone buying a driver championship. And even if he wanted to throw everything he could at Lance, new spending rules would make this very difficult. For me the business choice is obvious, and Aston Martin offers huge upside potential if Lawrence Stroll is like Keyser Söze from 1995 film, The Usual Suspects.

At one point in the movie, the characters tell a story about Keyser Söze, a legendary gangster. Apparently a rival gang kidnapped his family to try and bend Keyser Söze to their will. Keyser Söze found the kidnappers, and killed all of them except one. With this last kidnapper as a witness he then killed his family to show that no one could ever control him or threaten him, and left this kidnapper alive to make sure that everyone would know that no one could get to him, that business was more important than family.

From a business perspective, Aston Martin should fire Lance Stroll, and hire a British driver who could lean into the existing James Bond legacy of the brand. George Russell would be an obvious choice. He would also significantly boost the chances of a manufacturers championship and all the kudos that would bring to the brand. I do not know the mind of Lawrence Stroll, so your guess is as good as mine. If he continues to put family before business in a rising interest rate environment, then the stock is too risky for my liking. If he fires Lance, and focuses on brand building, then I think the strategy could work. As a karting parent, I find it unimaginable that Lawrence would fire his son - but then again, I am not a billionaire. I leave it to your judgement, is Lawrence Stroll a Keyser Söze?

(Thank you to my karting parent friends Nici Chapfield and Travis Domain for helping me generate this idea. All errors and objectionable bits are mine alone.)

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In my fiftieth year on this planet, I can confirm that old habits die hard. For years my investment process always started with macro, before I would think about anything else. And even though I “hate” bonds, even I have to admit recent macro data from the US makes me think that maybe bonds are a buy here.

Despite concerted efforts by the current government, net migration to the UK reached a new all-time high of over 600,000 in 2022 according to the Office of National Statistics (ONS).  Students are the single biggest group of immigrants, with over 361,000 arriving in 2022, up from 301,000 in 2021.  In comparison immigration for humanitarian reasons rose to 172,000 in 2022 from 57,000 the year before, largely driven by one-off increases from Ukraine and Hong Kong.  As late as 1992, the UK was a net exporter of people. At 600,000 net migration is 1% of the UK population, and makes the net immigration to the UK in line with other traditional immigrant nations such as Australia, US, and Canada.

The ONS notes that student immigration tends to be short term before reversing; however, Home Office data suggests a long-term trend at work here: the UK is allowing more students to come to study.  Home Office data, which includes Q1 2023, shows that student visa issuance is at all-time high.

The Conservative Party’s target of bringing net immigration below 100,000 seems incompatible with an annual issuance of student visas of over 600,000.  To meet its political commitments of lower immigration, the UK government could slash student visa issuance.  However, this policy would be extremely problematic. According to the Higher Education Statistics Agency (HESA) foreign students make up 25 percent of all students in higher education.  For full-time post-graduate studies, they make up 65 percent of all students. 

Foreign students pay much higher fees than UK residents accounting for over half the tuition revenue at major UK universities.  The issue is that this revenue stream particularly relies on Chinese students, who combine a huge desire for higher education with the cash to pay for it.  Tuition fees are by far the main source of income for UK higher education.

The success of the UK higher education industry conflicts with another government policy: to reduce economic reliance on China.  Visas to Chinese students have fallen slightly in recent years, but this limits the ability of universities to increase tuition revenue.  To diversify sources of students and grow tuition revenue, the UK now accepts more students from elsewhere. 

In recent years visas to students from India, Other Asia (mainly Pakistan) and Nigeria have surged.  The problem is that these students pay less than Chinese students.  In addition, leaving the EU has also meant that EU students face higher tuition fees, leading to a decline in their numbers.

According to HESA, the most popular university for Chinese students in the UK is University College of London (UCL).  At UCL, UK students pay £9,250 a year, while foreign students pay up to £31,270 a year. UCL is the highest earning university in the UK, pulling in £712 million in tuition fees.

The most popular university in the UK for Indian, Pakistani, and Nigerian students is the University of Hertfordshire, a former polytechnic.  UK students pay £9,250 per year to attend University of Hertfordshire, whilst it is £14,750 for foreign students.  The University of Hertfordshire is around the 30th highest earning university, with £235 million in tuition fees.

One way to reduce immigration would be to cap or reduce the number of Chinese students and raise domestic student tuition fees to compensate universities for the loss of revenue.  Raising tuition fees is a deeply unpopular policy, though, and played a part in the implosion of the Liberal Democrats in the 2015 election. 

The UK has loosened visa requirements for students from elsewhere, rather than raise tuition fees, but these students pay far less than Chinese students, so many more students are needed, which pushes up net immigration numbers.  The UK government faces a choice between higher tuition fees, or high levels of immigration.  Given the experience of the Liberal Democrats, the Conservative government apparently believes the political cost of high levels of immigration is less than the cost of raising domestic tuition fees.  High levels of immigration to the UK looks set to continue.

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