This has not been the century for private investors. The UK equity market return over the past 15 years has only been 1 per cent a year, and few investors have achieved even that, after management and dealing costs.
Bond or equity markets?
Investors might possibly have done better with fixed income investments, but even that is questionable. These markets have become the private paddling pools of professional market makers, reacting to every hint of a change in central bank thinking. Nor should any sensible private investor think of locking money away in a 20- or 30-year bond, yielding less than 2 per cent a year; at any moment the market will finally appreciate that central bankers have lost control of monetary policy and that, like the politicians, these also have no ideas on how to restore economic growth.
Then the loss of capital will be at least as great as that suffered by investors at the end of the 20th century with the bursting of the tech bubble and the beginning of this bear market. So investors must be like engineers, or military planners, and first agree and understand their objective, then identify the resources needed to reach it, accept the importance of time and patience within such a strategy, and only then begin the attack.
Kiss in theory
Investment is simple in theory. The objective is to obtain a return on savings – or capital, however defined – sufficient to live on for those retired and, for those still working, more than can be achieved from a risk-free asset such as a bank deposit. The method is to identify companies that have stakes in growing markets, proven quality management, and sufficient maturity to survive the bad times; these always come.
If the dividend yield is insufficient for the investor’s needs, then the portfolio can be seeded with some fixed interest securities, provided again that the yields available take sufficient notice of the likelihood of inflation or financial meltdown. Then all that is needed is time to allow for dividend growth, and patience to prevent unnecessary dealing if – and when – one of the portfolio constituents looks too weak or too strong.
Kiss in practice
For those investors without hope after the disasters of the past 20 years, the Association of Investment Companies (AIC) has produced a study that should give them courage and hope for the future even in today’s markets.
The loss of the UK’s stockbrokers after the Big Bang of 1987 meant a loss of ‘buy-side’ investment analysis for the private investor; however catastrophic that loss, it can at least be found in the corporate objectives and management structure of investment trusts.
This study is based on the 23 investment trusts that make up the UK Equity Income sector of the AIC database, and the average return of those trusts. Any investor needing income – or persuaded that ‘value’ rather than ‘growth’ is the better policy – could have invested £100,000 on 31 December 1995 in the average of these trusts, and received an income one year later of £3,826 – rather less than could have been earned with a deposit in a bank.
But over the next 20 years that dividend grew by 4.6 per cent a year while, after the banking collapse of 2007/8, retail bank deposit rates fell to between 2 and 3 per cent, or just about the same as inflation. By the end of December 2015 the dividend income on this portfolio had increased to £8,993 annually, keeping the investor’s income well ahead of the rise in the cost of living.
In those 20 years, not only would the investor have received their capital back with a total of £124,548 dividend payments, but would also have seen the original capital of £100,000 more than double to £215,874 – an increased value of the capital of 116 per cent. This is both the purpose and justification of equity investment, both for the individual and the corporate pension fund.
Kiss in the future
This performance is unlikely to be repeated during the next 20 years. In the 1990s, investors were excited over ETFs (exchange-traded funds) and, at least on the professional level, the opportunities apparently offered by ‘smart beta’ tactics. Investment trusts were a tiny part of the market, a leftover from Victorian times, and ignored by investors, IFAs and professional management firms.
So most trusts sold on a discount to their Net Asset Value (Nav) and the buyer of the shares was acquiring a portfolio of shares at less than their current market price.
As the years went by, the more contrarian investors began to appreciate that ‘closed-ended’ trusts had advantages over unit trusts and ETFs. Costs were lower, performance better, and corporate governance more attuned to investors needs – performance with existing money, and not to attract additional funds.
Slowly those discounts began to close, and this neglected sector of the market began to receive more attention, which brought improved management, better marketing, and new investment sectors.
Suddenly, just as in the 19th century, trusts were again offering investors access to markets that were enticing, but too dangerous on their own – such as infrastructure, peer-to-peer lending, private equity, frontier markets and ‘new’ technology.
Kiss today
And for managements that failed, their investors were aware of others who felt that they could do better. This was the fate of the doyen of the sector, Alliance Trust. Perhaps Dundee-based Alliance thought it could be a British equivalent of Warren Buffett and his Omaha-based Berkshire Hathaway. It was the largest of all global trusts, it had increased its dividend every year for more years than many of its investors had lived, had established a ‘platform’ – Alliance Trust & Savings – to look after the administration of its investors, and even an investment function to manage ‘other people’s money’.
Investment performance was relatively good, compared with its peers in the global sector, and investor loyalty to the board was high.
However good the investment management though, it could not overcome the basic failure of the board in its key role; costs were far too high, both from the losses on the two ancillary businesses, and the amounts they were paying themselves. Last year an American hedge fund group finally gained control.
The board has been reconstituted, already saving well over £1m in ongoing costs, and profit targets set for what are now independent businesses – ATS and ATI. Failure to achieve sustainable profitability – and neither seems likely – will see these sold off with a further diminution of management costs.
It may take another two or three years before this is achieved, and Alliance once again becomes a normal investment trust but, at a discount of 10 per cent to asset value, that becomes a worthwhile wait.
And with a ‘global’ investment mandate, Alliance can escape the political and economic problems of the UK and the EU. Sadly, these are likely to get worse as our politicians prove, as did the former members of the Alliance board, incapable of matching objectives to resources.
