At the time it was generally agreed the problem had three main strands: too much debt, overambitious and greedy bankers, and banks that were both too big to manage yet also too big to fail. It was soon accepted that this was not a US-only disaster, but that others, in particular European banks, had been gullible and willing buyers of toxic American assets.
The next decade of bank reconstruction and financial austerity devastated economic growth and trade. Indeed, British citizens, according to a recent report from the Institute of Fiscal Studies, are on average £800 a year worse off. It means that this is the first 10-year stretch since the 19th century when Britons are worse off at the end of it than they were at the beginning.
Hidden in plain sight
Central bankers avoided a repeat of the very worst effects of the depression of the 1930s by making money available, and at very cheap or even zero rates.
The consensus of these years, as far as financial advisers were concerned, was the overwhelming need for those with cash to find investments with yield, and that such needs could not be met safely via either the banks, the bond markets or the stockmarket.
Yet this was not true, as Table 1 and Table 2 show. Not only does a £100,000 investment company portfolio currently yield a better-than-average income, it would also have produced significant capital growth over the course of the past decade to add substantially to that income.
Why investment trusts succeed when others do not is that they focus on buying an appropriate income for the capital they manage. The original investments were bullion (gold and silver) and land; the former bought arms and men to use them, while land was a space in which crops could be cultivated and cattle could be bred. Later came tenant farming, flour mills, housing and mortgages.
There have always been the rich and powerful, and such people have always had a need for income, either to pay for retainers and servants, or for display. Brokers and bankers profited as the financial markets developed in size and complexity, and themselves became necessary and knowledgeable intermediaries.
Behavioural basis
Even before the advent of the computer, some were fascinated by numbers as a way of identifying the secrets of investment success. Jesse Livermore was one of the greatest stockmarket operators of the interwar years, making and losing many fortunes that at times ran into the millions of pounds, and seeking to improve his skills as an investor by using mathematical models, as well as attempting to control his emotions.
From the 1950s onwards, computers and professors had a field day developing theories of stockmarket behaviour. Of these, the most important was the efficient market hypothesis. This kept senior businessmen happy that their company pension funds were safe, if invested in the stockmarkets, since it argued that all information was known, and prices could not be manipulated. Fortunes could be made, but not necessarily lost.
The modern era
It was this theory that became established market practice, together with ad valorem charging practices. This benefitted investment managers, and helped introduce a variety of other specialist advisers, although always at the cost of reducing the marginal returns that can be expected within investment markets. But an unacknowledged weakness of all these theories is that everything is based on detailed history, and takes no account of the future, let alone human emotions.
Yet history shows markets are controlled more by emotion than facts. Since at least the late 17th century, natural science has worked on scepticism, and disproving proposed hypotheses, in the course of identifying what works, what is believed to work, and that which is based on facts and which on faith.
There is no concrete evidence that modern portfolio theory works and, compared with the earlier belief in income generation, much current thinking is more based on faith and authority than practical reality. So also is much economic theory, as is the political attitude to banking problems. Despite the 2008 crash, nothing has changed except for the worse – higher indebtedness, bigger banks, more extreme gearing. There will be another crash, but when exactly this will happen is, as ever, another unknown.
If financial advisers are to help clients, they need to rethink their own beliefs and concentrate on what has been proved to work, not on unsubstantiated promises. This means investment trusts, and using individual trusts to give real diversification, based both on future guesses as well as current reality.
This is what the portfolio outlined in Tables 1 and 2 is designed to do, as I will explain in next month’s column.
