UKNov 22 2016

Short-term trauma for UK equities but long view is robust

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Short-term trauma for UK equities but long view is robust

Veteran investor Warren Buffett famously observed: “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”

The 2016 edition of the Barclays Equity Gilt Study, which reveals asset class returns going back 116 years, provides a picture of the nature of investment returns.

The data is in real (inflation adjusted) terms and is like-for-like across asset classes. For UK equities, the real returns to the end of December 2015 over one year, 10 years, 20 years, 50 years and since inception were -0.1 per cent, 2.3 per cent, 3.7 per cent, 5.6 per cent and 5 per cent, respectively. 

In the longer term, equities have provided a very attractive compound real return. However, recent periods have been disappointing as equities suffered poor returns for two consecutive years. The worst was 2014 at -0.4 per cent. This has adversely affected the short- and medium-term numbers.

This prolonged malaise in equities is unusual, as the data shows that equities outperform cash 91 per cent of the time over 10 years

Looking more widely, last year was very dull across all asset classes with the only positive number being recorded that of inflation, 1.2 per cent. Otherwise returns were negative across the board, with equities -0.1 per cent, gilts -0.6 per cent, corporate bonds -0.5 per cent, index-linked gilts -3.4 per cent and cash -0.7 per cent. 

This was in contrast to 2014 where, despite equities and cash doing badly, fixed income soared.

In the 10 years to the end of 2014, gilts outperformed equities at 4.1 per cent versus 3.7 per cent, and the same was true for last year, although there were lower compound returns at 2.3 per cent and 3 per cent. The same story plays out over 20 years with equity returns at 3.7 per cent and bonds offering 4.3 per cent.

This prolonged malaise in equities is unusual, as the data shows that equities outperform cash 91 per cent of the time over 10 years and gilts 79 per cent of the time over the same period.

The other key observation, particularly for those who spend the income from their investments, is the importance of reinvestment. 

Looking at the real returns from gilts and equities is revealing. If £100 was invested at the end of 1899 without reinvesting, the income produced a real return in equities of £177 and just 72p from gilts (nominal figures were £14,231 and £58).

However, with income reinvested these figures shift to £28,232 and £456 real, or more dramatically in nominal terms to £2,265,437 and £36,395.

Over the longer term, the natural home for a risk-taking investor is equities, which is likely to be the case in future. Equity investors should be rewarded with a higher return as a reward for accepting the higher risk, and the likelihood of gilts continuing to produce similar returns to the past 20 years is diminished by simple mathematics. 

The 20-year real return for gilts to the end of 2015 was 4.3 per cent real. However, with bond yields now standing at historically low levels (the UK 10-year gilt currently yields 0.96 per cent) yields would have to continue to decline from already low levels and inflation looks likely to pick up, at least in the short term, due to the Brexit vote and subsequent devaluation of sterling.

The UK has suffered from a protracted period of poor performance from its largest companies. Until this year, the FTSE 100 index has massively underperformed the more domestic-orientated FTSE Mid 250 and Small Cap indices. 

The longer term case for equity investment remains robust, albeit we are living through a relatively traumatic period politically and economically and this has dampened equity returns for a significant period.

Stephen Watson is chief investment officer at Beaufort Investment Management