Relative or absolute returns?
A rising tide lifts all boats, and good investing times persuaded many to believe that they were clever investors. Since 1982 the S&P has risen tenfold, while the FTSE 100 is more than five times higher.
Those carefree decades of instant riches ended in 2000, and the first decade of this millennium has shown an overall loss for the London market.
What lies ahead?
There is no agreement on what constitutes bull and bear markets, but it makes sense to assume that stock market cycles are counted in years rather than months.
It took America 18 years of going sideways before the Dow Jones index exceeded 1,000 in 1982, and the London market was equally range bound from the Macmillan ìyou never had it so goodî election of 1959 to its worst ever crash in 1974.
The fervent wish of politicians and investors alike, that the last decade ‘becomes horrible history’, is no guarantee that normal economic and stock market growth will soon be resumed. Indeed both bond and equity markets are priced on the basis not that this will happen, but that it has already happened, with analytical concerns over double-dip recession simply exercises in exorcism.
The optimists may well be right but, as the Irish bailout shows, there are many opportunities for policy mistakes to disrupt economic recovery. After the roller-coaster ride of the last decade, few investors wish to repeat their losses, and only traders can feel comfortable in this market.
What is investment risk?
The examples of investment trust performance in December Taking Stock shows that above average performance exists and can be identified. But an important question of investment philosophy is hidden in that fact, and this is one that ought to be considered: is investment risk absolute or relative?
Does risk mean an actual or potential – that is, a not yet realised – loss of savings or capital, or is it just a matter of relative performance against some agreed benchmark?
The bull market years saw this relative concept of loss gaining ground amongst professional investing institutions. There were good reasons for this.
As the years went by, the institutions constituted more and more of the market, for private investors were marginalised by tax policy and the increased complexity of market instruments, as well as what appeared to be the greater professionalism needed to benefit from market movements.
Relative performance helped the institutions too; if they mostly constituted the market, it became harder and harder to do better than the market and so justify their fees. But establishing a benchmark – out of the many hundreds of existing indices – in consultation with their pension fund or charitable clients, and then performing against it was an entirely easier, but also more professional looking, activity.