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Barclays
Capital, the investment banking division of Barclays
Bank PLC, published the 53rd edition of its 2008
Equity Gilt Study, in February 2008.
“This year we examine the very
important relationship between inflation and
economic leverage. We comment on the generally
positive performance of hedge funds last year and
our colleagues at Barclays Global Investors talk
about factors that can reduce portfolio efficiency.
We recommend long term investors plan and supplement
hedging strategies to protect the value of their
portfolios from the damaging effects of inflation
and heightened volatility,”
commented Tim Bond, Head of
Asset Allocation at Barclays Capital.
John Authers
of the
Financial
Times
commented
that over
history, the
great enemy
of investors
has been
inflation.
Equities
have done
little more
than offer a
hedge
against it.
From 1899 to
1985, UK
equities'
real return,
compared
with UK
retail
prices, was
negative.
Stocks often
failed to
keep up with
inflation.
By 2007, the
real return
on UK
equities
since 1899
was 109 per
cent, all of
which had in
effect been
achieved in
the past two
decades.
Over the
same period,
gilts lost
99.3 per
cent of real
purchasing
power.
What is
remarkable
about the
past 20
years is not
the
performance
of stocks,
but the way
inflation
was
contained.
Highlights of this year’s edition include:
For richer, for
poorer – Resource scarcity
is the single most important social, political and
economic factor of our era and will remain so for
the foreseeable future. The Equity Gilt Study
examines how resource scarcity is likely to wreak
significant changes to the global economy, ending
the long-term trend of decreasing volatility in
growth and inflation. The net result of intensifying
natural resource scarcity is an increase in
structural upward pressures on inflation and a
worsening trade-off between inflation and growth.
Asset Returns
– In the UK, cash was the best performing
asset returning 1.8% after inflation. Equities
posted a lacklustre performance underperforming
bonds in the UK and US. Equity and corporate bond
performance was damaged by the summer credit
squeeze, while government bond returns were weak in
the face of rising monetary policy pressure in the
first half of 2007. In the US, equities managed to outperform
cash, however, stocks lagged behind nominal and
index linked bonds.
The
UK Munro Fund Managers say stock markets go up and down as events unfold, and the news loves
nothing more than to report a big fall. Crashes are much more
newsworthy than a steadily rising market. But the fact is, as
research from Barclays Bank shows, that the stock market generally
gives better returns than other assets over periods of longer than
ten years. It is not always the case, but it is true more often than
not. In the ten years to the end of 2007 equities, that is shares in
the UK stock market, delivered an annual average return of 3.1%. Not
fantastic and less than the 4.2% returned by corporate bonds. But
it is more than the 2.5% you got by holding cash. However, over a
longer period, the last 20 years, equities have delivered an average
annual return of 6.7% compared to 5.1% for bonds and 3.5% for cash.
In more detail the long term real returns, i.e. after allowing for
inflation, up to the end of 2007 are shown in the table below:
|
% |
2007
|
10 Years
|
20 Years
|
50 Years
|
108 Years
|
| Equities |
1.0
|
3.1
|
6.7
|
7.2
|
5.3
|
| Gilts |
-1.2
|
3.3
|
5.1
|
2.4
|
1.1
|
| Cash |
1.8
|
2.5
|
3.5
|
2.0
|
1.0
|
This table shows that 2007 was not good for shares, with real cash
returns outperforming equity returns for the first time since 2001.
The last ten years have not been that bright either, with gilts
outperforming equities by a small amount. But that is the exception
as the other data shows. What it does show is that equity returns
are unevenly distributed over time. But over a long period of time
equities always do better than bonds. This extra return is known as
the equity risk premium and is essentially the compensation an
investor gets for putting up with volatile returns over short
periods. Another way to express this is to look at the variability
in returns over different holding periods. The graph above from the
Barclays Equity Gilt study from 2008 demonstrates that equity
returns can be very volatile in any one year period. But as the
holding period increases the volatility diminishes and become more
skewed to a positive outcome. And after ten years they always beat
bonds. So the longer you hold shares the more chance you have of
making more money than from other assets.
Munro says time is a significant
influence in reducing volatility. But another factor is
perhaps even more important and that is the value added by
reinvesting the income stream. Most shares pay out a
dividend from the profits earned and this cash is the only
tangible benefit a shareholder gets from investing in
equities until he or she sells the holding. But by
reinvesting those dividends back into shares the investor
gets the benefit of compound interest on a bigger
investment. And compound returns are where you make your
money over time. Here is how the magic of compound returns
works. Imagine you have £2,000 to invest on January 1st. You
put £1,000 on deposit with bank at 2.9% and you put £1,000
into the stock market in an average year. On December 31st
those funds have grown to £1,029 and £1,066 respectively,
before fees. Now suppose that you leave those funds where
they are for another year so your starting figures are
£1,029 and £1,066. After another year of similar returns
those two pots are worth £1,058 and £1,136. The difference
between the two is widening more and more every year. Repeat
that process for ten years and the figures start to look
quite impressive. Remember though that these figures are
before fees, and the compound effect of fees is just as
powerful.
The Barclays
Equity Gilt Study has provided an even more powerful
demonstration of the benefits of receiving an income and
then reinvesting it. In its 2008 study it provides two
tables that show the difference in a hypothetical portfolio
of £100 invested in 1899. The difference between £13,580 and
£1,641,485 makes the case for reinvesting income very
eloquently.
Cash is certainly the best
place to hold savings that you might need to access within
ten years. Even better is to pay off any debt that you can,
as long as you don’t incur any penalties. Paying down debt
is risk free, you don’t have to pay any tax on the interest
income and almost certainly the interest the bank charges on
borrowings will be more than it pays you on savings. After
all, that is how banks make their money.
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