Personal Finance: The Jonathan Davis Column - The simple way to profit

For decades Cambridge dons bought shares, then left them alone. Two years ago, they meddled

A cautionary tale this week from the land of academia, which highlights the merits of the old-fashioned virtues of simplicity and constancy when it comes to devising investment strategy. The story comes courtesy of the Investors Chronicle, which for many years has reported - under the sobriquet Academic Investor - the annual investment performance of an anonymous Cambridge University college. I commented on the college's unusual but highly successful investment strategy in this column a couple of years ago.

The most remarkable feature of the college's approach to planning its investments is its extreme simplicity. As long ago as 1953, years before the cult of the equity had taken hold in this country, the college took the then extremely bold decision to switch all its investment capital out of bonds and invest it in the stock market. This despite the fact that the college relied - and continues to rely - on income from its investments to sustain its (I am quite sure) comfortable way of life.

Not content with such a radical shift of tack, the college also became one of the first institutions in this county to adopt what we know as a passive investment strategy. It assembled a broadly diversified portfolio of equities and imposed on itself the simple rule that it would only review the portfolio on one given day a year. For the rest of the year, it would simply sit back and leave the market to take its course. It would make no attempt to pick stocks during the year, and even on its one annual review it would try to avoid making any big changes just for the sake of it.

At the heart of this approach was the college's realisation - well ahead of its time - that there is little point in trying to outperform the market averages without some reason for believing that you can actually achieve such outperformance. The college's time horizon as an investor is long term - at least 100 years, it reckons - and the view of its investment committee is that it has no real basis for thinking it can work out which stocks are going to do best over that time frame. In its own words: "Nobody really has any idea what the future will bring over the next century or two, so an active policy of portfolio management is likely to give worse results than a passive one, because every change of investment incurs dealing costs."

By sticking to its simple policy of minimal changes in its portfolio, the college not only saves on the transaction costs of buying and selling new shares, but also avoids the financial burden of paying management and advisory fees to fund managers or financial advisers - an investment that often fails to yield commensurate rewards. In essence, therefore, the college has for more than 40 years been pursuing a policy of low-cost, passive investment management - the same strategy that, in my view and that of a growing number of others, should logically form the basis of many ordinary investors' strategy.

Needless to say, the college has been remarkably well rewarded for its prescience in avoiding trying to be too clever in its stock market dealings. As the charts show, both its capital and income have fluctuated with the market as a whole, but over the long haul its results have continued both to grow in real terms and to outperform those of the All Share index over the same period. The track record is an excellent advertisement for the merits of simplicity in investment. The college is entitled to put two fingers up to those who, as its chronicler says, prefer to call its approach "simple-minded" rather than "simple".

So why, then, did I describe this as a cautionary tale? Well, sad to report, for the last two years the dons at the college have by their own admission made the mistake of abandoning their own best self-denying ordinance and fiddling with their tried and tested policy. Convinced that the market was becoming dangerously overvalued at their annual review last summer, they decided to modify their policy. First they made the historic decision to switch 25 per cent of their portfolio out of shares and into Treasury bonds, on the grounds that share prices had become "unjustifiably high". Then they compounded the error by using traded options on the main indices to guard against the risk of a significant fall in the market's overall level.

Now it ill behoves me to take issue with these actions, since I have been urging caution about share price valuations and praising the merits of bonds for some time. (The index options are another matter.) Yet I have to record the doleful news that the college's fateful decision has not so far been a conspicuous success. In one sense the college has enjoyed a satisfactory year since its change of tack last year. Its investments have yielded a total return of 14 per cent, comfortably above inflation at 3 per cent - and more than adequate.

The only trouble is that, had the college simply left well alone, and ignored the siren charms of its options, the portfolio's capital value, instead of rising 9.4 per cent, would have risen by 16.6 per cent. (When the market continued to rise, the options lost a significant portion of their value.) If it had stuck to its 100 per cent weighting in equities, rather than moving into bonds, the chances are that it would have matched the 25 per cent gain that anyone investing in a tracker fund could have achieved during the year.

"We are frankly unhappy," concludes a chastened Academic Investor, "about departing from our traditional simple policy. We hope that in future years we will see no reason against reverting to a simple policy which involves no attempt to be clever about predicting movements in market prices." Now they have moved some of their equity holdings into low-cost tracker funds - but are still using a put on the Footsie index to reduce their exposure to equities still further. Will they look smarter next year? It will be interesting to see.

Have you tried new the Independent Digital Edition apps?
Life and Style
ebookNow available in paperback
ebooks
ebookA delicious collection of 50 meaty main courses
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

SPONSORED FEATURES

ES Rentals

    iJobs Job Widget
    iJobs General

    Recruitment Genius: Office / Sales Manager

    £22000 - £32000 per annum: Recruitment Genius: Established and expanding South...

    Recruitment Genius: Administrative Assistant / Order Fulfilment

    £14000 per annum: Recruitment Genius: An exciting opportunity to join a thrivi...

    SThree: Trainee Recruitment Consultant

    £18000 - £23000 per annum + Uncapped OTE: SThree: Trainee Recruitment Consulta...

    SThree: Trainee Recruitment Consultant

    £18000 - £23000 per annum + Uncapped OTE: SThree: Trainee Recruitment Consulta...

    Day In a Page

    Refugee crisis: David Cameron lowered the flag for the dead king of Saudi Arabia - will he do the same honour for little Aylan Kurdi?

    Cameron lowered the flag for the dead king of Saudi Arabia...

    But will he do the same honour for little Aylan Kurdi, asks Robert Fisk
    Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

    Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

    Humanity must be at the heart of politics, says Jeremy Corbyn
    Joe Biden's 'tease tour': Could the US Vice-President be testing the water for a presidential run?

    Joe Biden's 'tease tour'

    Could the US Vice-President be testing the water for a presidential run?
    Britain's 24-hour culture: With the 'leisured society' a distant dream we're working longer and less regular hours than ever

    Britain's 24-hour culture

    With the 'leisured society' a distant dream we're working longer and less regular hours than ever
    Diplomacy board game: Treachery is the way to win - which makes it just like the real thing

    The addictive nature of Diplomacy

    Bullying, betrayal, aggression – it may be just a board game, but the family that plays Diplomacy may never look at each other in the same way again
    Lady Chatterley's Lover: Racy underwear for fans of DH Lawrence's equally racy tome

    Fashion: Ooh, Lady Chatterley!

    Take inspiration from DH Lawrence's racy tome with equally racy underwear
    8 best children's clocks

    Tick-tock: 8 best children's clocks

    Whether you’re teaching them to tell the time or putting the finishing touches to a nursery, there’s a ticker for that
    Charlie Austin: Queens Park Rangers striker says ‘If the move is not right, I’m not going’

    Charlie Austin: ‘If the move is not right, I’m not going’

    After hitting 18 goals in the Premier League last season, the QPR striker was the great non-deal of transfer deadline day. But he says he'd preferred another shot at promotion
    Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

    How Isis profits from destruction of antiquities

    Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
    Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

    'If we lose touch we’ll end up with two decades of the Tories'

    In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea
    Tunisia fears its Arab Spring could be reversed as the new regime becomes as intolerant of dissent as its predecessor

    The Arab Spring reversed

    Tunisian protesters fear that a new law will whitewash corrupt businessmen and officials, but they are finding that the new regime is becoming as intolerant of dissent as its predecessor
    King Arthur: Legendary figure was real and lived most of his life in Strathclyde, academic claims

    Academic claims King Arthur was real - and reveals where he lived

    Dr Andrew Breeze says the legendary figure did exist – but was a general, not a king
    Who is Oliver Bonas and how has he captured middle-class hearts?

    Who is Oliver Bonas?

    It's the first high-street store to pay its staff the living wage, and it saw out the recession in style
    Earth has 'lost more than half its trees' since humans first started cutting them down

    Axe-wielding Man fells half the world’s trees – leaving us just 422 each

    However, the number of trees may be eight times higher than previously thought
    60 years of Scalextric: Model cars are now stuffed with as much tech as real ones

    60 years of Scalextric

    Model cars are now stuffed with as much tech as real ones