It has been hard to be a successful investor over the past 15 years. The chances are that it will be even harder over the next fifteen that now follow.
How not to invest
Terry Smith was one of the City’s best-known analysts, but his unconventional thinking drove him out of the major stockbroking firms to set up his own business. Five years later, he wrote in the Financial Times [21.11.15] of his successful development of his unit trust Fundsmith.
“One thing I have observed is the obsession of market commentators, investors and advisers with macroeconomics, interest rates, quantitative easing, asset allocation, regional geographical allocation, currencies, developed markets versus emerging markets – whereas they almost never talk about investing in good companies.
What has continued to amaze me throughout the past five years is not just this largely pointless obsession with factors which are unknowable, largely irrelevant, or both, but how infrequently I hear fund managers or investors talk about investing in something which is good.”
It is good companies that will be the key to success over the next decade or more but of even greater importance to investors is their standard of living in retirement. Market returns are going to be bad, and investments that cannot do significantly better than the markets are going to leave their owners impoverished and dependent on state aid.
Not too much hope should be placed on that. To be sure, the chancellor’s latest spending plan shows that he is determined to change the structure of government spending in favour of those that vote. Spending on education and business is expected to reduce from
24 per cent of GDP in 2008 to 20 per cent by 2020, while overall the amount spent on the old and dying increases from 35 per cent to 42 per cent by 2020. But it is the young and energetic that drive an economy, and increasing productivity that makes us all better off.
Bull and bear markets
Stockbroker economics assure us that shares are always cheap, and that markets are, if not in a bull phase, cheap since they are at a bear market low. But a look at the 20th century shows clearly that stockbroker economics are wrong. Stock market cycles take a long time to play out, as the broad Wall Street figures show in Table 1.
The length of the cycle generally reflects the level of prior market valuations, or the earnings per share of the companies that comprise the market. The average P/E over the century was about 15 times but ranged from five times at bear market bottoms to 44 times at the time of the biggest frenzy in history, or the market top in 2000.
Further analysis of P/E ratios shows quite distinctly the effect of market valuations on the movements of markets. Sustained bear markets generally commence once markets start selling at above 25 times, and only finish once markets are priced at 10 times or less. This is not the case today. Whether your choice of valuation is Professor Schiller’s cyclically adjusted price earnings ratio (Cape) or Tobin’s Q [or total value of corporate assets], markets are very overvalued.
Additional analysis proves that reversion to the mean – a rule of statistics as well as life – takes time. The emotions of investors drive market movements, and these take time to change. Moreover, this unwillingness works both ways so markets oscillate until the pendulum finally achieves rest. The Table shows an average 15- to 20-year swing from top to bottom and back again.
Finding the good companies
Pensioners have already discovered that management costs, together with the errors commented on by Terry Smith, have denied them even the derisory market returns of the past 15 years. For those investors able and willing to do some analysis, a new website called voxmarkets offers individual company analysis together with investor comments.
But the best answer for those investors not fascinated by financial matters is, as described in December’s Investment Spotlight, a choice of half-a-dozen investment trusts. The average investment trust returned more than 10 per cent a year over the past 30 years, some 50 per cent better than market returns; the best returned some 12-14 per cent a year.
The proven key to successful investment is, and has always been, the purchase of a stable but growing income. Today, this can only come from the purchase of shares. Central bank manipulation of markets at the behest of their political masters means that government bonds are a risk to investors’ capital; this dangerous trap will be sprung once interest rates return to normal.
A canard long perpetrated by the regulators is “past performance is no guarantee of the future”. This is akin to saying that the next time Djokovic plays a tennis match, he only has a 50:50 chance of winning. Skill counts with investment, as with tennis and other human pursuits, and investment trusts with their corporate structure are designed to nurture investment skills.
Identifying the markets
The industrial revolution started in England because wages were high, and so justified capital investment that would reduce costs. Presently the UK is a ‘low-wage, low-skilled’ economy and no amount of wishing by the government will change that; policy action is needed, but the apprenticeships
so lauded are, as Ofsted reported, worth neither the money nor the time. The apprenticeship levy introduced by the autumn statement is rightly seen as a tax on employment.
Historically, investment trusts either specialised in the UK economy, or as ‘global investors’. This, more often than not, meant Anglo-American investments although, today, that remit has widened. The core holdings of an investment trust portfolio are best chosen from the ‘global’ category, until the skill, wages and productivity of the UK workforce are as the government wishes, and not as they are today.
All investment trusts can be researched for free on the websites of Numis Securities or the Association of Investment Companies (AIC). Investment trusts should never be bought at a premium to their net asset values [Nav] since history shows that these never last. And at the very least, investors should read the annual reports of the investment trusts in which they are interested and reassure themselves that the board of directors is very conscious of costs, agrees and understands the investment strategy, and is in tune with the tactics of the investment manager.
If it is at all possible, investors should accept the going market yields; ‘high yield’ investment sounds attractive but all too often these are paid at the cost of future income growth. For above average rates it is better to look to some of the newer sectors of the IT market – such as the property, infrastructure, peer-to-peer lending, and renewable energy sectors. These, however, should never be more than 30 per cent of the total investment trust portfolio, since the risks are newer and less easily quantified.
Today shares are selling at more expensive valuations than any time in history other than 1929 or 2000. There is risk in buying shares, especially indexed market funds or even sales-orientated unit trusts, or the ingenious but poorly understood multi-asset funds. Good investment trust boards and managers know the tricks of reducing risk, and produced good results despite the ups and downs of those 30 years from 1985 to 2015. And cash is always the alternative in a deflationary world – but how many investors can live off a yield of between one to two per cent?
