As we near the end of this series of blogs, reviewing the long term investment opportunity for retirement provision or other long term savings, the writer thought it would be useful to summarise – in tabular and aide memoire format - some of the asset classes we have examined and potential investment vehicles considered.
Annual total returns on UK Equity, UK Gilts, Cash & Inflation 1982-2011
The UK Equity returns are based on the FTSE UK All Share Total Return index UK Bond returns are based on an equally weighted mix of the FTSE British Government Fixed All Stocks Total Return index and the Barclays Capital £ Aggregate Bond Total Return index, Cash returns are based on 3 month London Interbank Offer rate (LIBOR) and Inflation is based on the UK Retail Price index (RPI). Source: Thomson Datastream.
The above table uses total return indices in order to show income-inclusive performance. As anyone with experience of life – never mind stock markets - would expect, there is significant variance and volatility from year to year. This is most obvious in scrutinising equity returns, but applies to bonds too; going back another decade would have revealed much higher absolute numbers for cash and inflation. (Digressing with a personal anecdote, the writer’s ‘across-the-board’ salary increase in 1975 was 23% - equating to inflation – with Minimum Lending Rate having been 13% in the previous year).
If we were to add a column in the above table, to reflect the output of the domestic economy (notwithstanding the ever-declining content of UK revenue and profits within our equity market), almost without exception it would have shown positive numbers (using GDP in actual, not real, terms). As such, one could conclude that volatility has always been present, in each of our lifetimes, but the influencing factors have perhaps inevitably varied: change in ruling government probably had greater impact on economic & fiscal policy in the 1960-1990 period, while technologically-enabled globalisation has been a bigger factor since. Going forward, one thing is for sure: the only fact unlikely to change is change itself.
The reader might wonder why hedge funds do not appear in the above table, but the writer could not confidently produce robust data on these assets over the desired 30 year time horizon. By contrast, rigorous information on international stock markets (in local currency and sterling terms) and various individual commodities is available, but displaying such a plethora of information would not have been practical. We also leave those which are not readily liquid (property, private unlisted equity) or fungible (such as art, antiques, fine wine) to one side, for those interested to investigate further, and turn to look a little more closely at each core traditional UK asset class for investment. This has been done by looking at:
Historic total, real (after taking account of inflation) annual returns over long time horizons (50 years+).
Total, real annual returns over a shorter time horizon (5 years).
Current returns, by reference to immediate yield or valuation, on offer.
The immediate outlook for future returns.
Cash has typically delivered a positive real total return, when looking at Building Society or Bank deposit accounts over past decades, averaging +1.8% per annum over the past 50 years, or +1.0% over 100 years, to 2011. This has only been possible by selecting an account paying a consistently above average interest rate, but may still surprise investors today whose experience over the past 5 years is likely to have been of paltry – and below inflation – returns. The outlook for cash remains dull, as Official Bank (often termed Base) rate appears set to remain at its all-time low of 0.5% until 2014 at the earliest, and inflationary forces appear benign.
British Government Bonds have also usually delivered a positive real total return, based on medium dated 10 year conventional gilts, averaging +2.3% per annum over the past 50 years, or +1.2% over 100 years, to 2011. While longer dated stocks have typically exceeded those returns, RPI inflation based index-linkers have underperformed conventional gilts. All, but the very shortest maturity issues, have performed well in investors ‘flight to safety’ over the past 5 years. However, if UK government debt had lost its AAA rating (as so many other European countries have) a very different picture would have emerged – gilt prices would have fallen and yields risen. Positive real total returns on gilts from here appear limited, as valuations reflect the strong emotive influence of fear – the 5 year conventional gilt currently offers a gross yield to redemption of 0.6%, and the 10 year gilt pays 1.6% - with slowing domestic inflation limiting incremental upside to the inflation linkers.
Corporate Bonds have historically added value to bond investors prepared to move up the risk ladder from government debt. A diversified basket of conventional £-denominated issues, rated by credit agencies as being of investment grade quality, have typically offered a real return of +3.0% and, as investors accept more credit risk (and incorporate lower quality issues), so the return rises to 3.8% - midway between gilts and UK equities. This asset class outperformed domestic equity over the past 5 years but, featuring high (albeit diminishing) exposure to banks, has lagged government bonds. The current risk premium (compared to gilts) for both investment and lesser quality grade bonds is high, reflecting the risk-averse mood of investors, with a consequent BBB credit availability of 5% yield to maturity. Looking forward, risk-free interest rates can only realistically rise from current levels, but this negative factor is largely offset by an expectation that credit can improve – as anticipated delinquency in the corporate sector does not materialise.
UK Equity has provided additional returns to investors prepared to accept the higher risk of owning the equity portion of a company’s capital. This asset class has delivered an average total real return of +5.2% per annum over the past 50 years, or +5.0% over 100 years, to 2011. However, over the last 5 years, UK equity has had a roller coaster and ultimately disappointing ride; the FTSE index stood at a level of 6,700 in July 2007, before the unexpected global banking crisis brought index down to 3,512 in March 2009. Bouncing back to 5,750 by early 2010, the market has struggled to make progress since then against a backdrop of slowing economic growth. By reference to its historic valuation, and relative to cash and gilts, UK equity currently appears attractive based on an overall price/earnings multiple of 10 times (30 year historic average is 14.5x) and a more than twice covered dividend yield of 4% (which is high relative to cash & gilts, compared to the past 30 years).
Global Equity: we have previously argued that the UK equity market should be viewed as being representative of the global – rather than domestic – economy. This is borne out by looking at the performance of other leading international equity stock markets over the past 5 years; with every major bourse also lower. The US, which is the world’s biggest economy and financial market (accounting for almost half of total global equity market capitalisation), has held up better than most – being just 9% lower, by reference to the Dow Jones industrial index. Turning to Asia, Hong Kong’s Hang Seng index is 15% lower than its July 2007 level, co-inciding with the fall in our FTSE100, whereas Germany’s Dax 30 index has been somewhat weaker – falling by 20%. However, the weakest performance of the big equity markets is Japan; exacerbated by the country’s natural tragedy in early 2011, the Nikkei 225 index has fallen 51%.
Next week we will conclude this series of educational blogs by offering a few tips to prospective traders in equities and also discussing the merits, and possible shortcomings, of the prime ways an investor might seek to expedite an investment plan: from a DIY basis through to being fully advised and employing professional managers.
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.
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