Secrets Of Success: Safe haven with sparkling returns
Saturday 22 October 2005
Looking through the latest performance data for funds always throws up some interesting perspectives. As has been noted here many times, you can show almost anything you want to with statistics, but it is quite difficult - unless you review the data on a regular basis - for most investors to keep track of the important longer-term trends. Hindsight, as we know, is a wonderful thing, but it can give us some important lessons for the future, as well as useful perspective on the past.
What prompts this thought is taking a look at the data for the 10-year performance of UK registered funds. It so happens that the last 10 years have been an unusually dramatic period in the stock market. In retrospect, the decade falls neatly into three periods: first, the extraordinary five-year late flowering of the bull market from 1995 to 2000; then, a savage three-year bear market from 2000 to 2003; and finally, a two-and-a-half year rally, starting in the spring of 2003, which may or may not now be losing its momentum.
Where, with the benefit of hindsight, would our old friend Rip van Winkle have been wise to put his money 10 years ago, assuming that he went to sleep on 1 October 1995 and only woke up at the start of this month, refreshed and ready to give his portfolio its customary 10-year makeover?
Looking at the figures for the UK market first, his review would throw up some findings that may surprise you, especially given the things you have been reading in the media for the past 10 years.
For example, it turns out that of the major indices logged by Standard & Poor's Fund Expert, the best-performer is the FTSE Utilities index, which has returned 249 per cent over the past 10 years. The dullest segment of the market - in other words, the one regarded as the safest haven in the market - has been the one that has produced one of the most sparkling performances. Its return represents a 10-year compound return of 13 per cent a year. Of the main market segments, only the energy sector has done much better than that.
The Utilities index was closely followed by the FTSE High Yield index, which is defined as that half of the All-Share index that pays the highest dividends. This connection is not totally surprising, since many utilities are traditionally among the highest-yielding stocks.
Over the whole 10-year period, the High Yield index has outperformed its counterpart, the Low Yield index, by a massive margin, thus confirming the findings of many studies that dividend-paying stocks are normally the most productive long-term segment of the market.
In fact, if you look back over the past 20 years, which takes us back almost to the start of the great 1982 to 2000 bull market, high yield stocks have outperformed low yield stocks by some six percentage points a year (14 per cent against 8 per cent). The margin is the same over the past 10 years as well (11 per cent against 3 per cent).
Yet my question is: how many investors and how many advisers - in either 1985 or 1996 - were talking about the excitement of utility stocks, or indeed of high-yielding stocks? Precious few, is the answer.
It is true that any Rip van Winkles who did plump for utility or high-yield stocks (and then woke up by accident at some point in the middle of their slumbers) would have suffered some pangs of anxiety at the final peak of the bubble, as their shares went out of fashion in a big way.
Meanwhile growth stocks (and alleged growth stocks, to be more precise) hogged all the limelight. In both 1998 and 1999, high-yielding stocks underperformed low-yielders counterparts by 10 per cent in both years (although the return in both years was still positive).
That, however, merely underlines three eternal truths of the investment game, which are: one, that fashions will always lead to periods of underperformance, even in the most carefully selected and prudently managed portfolios; two, that investors are ill-advised to be bounced out of such holdings merely because the market (and most of the media) is chasing some more ephemeral dream at the time; and three, that such occasions are usually wonderful buying opportunities for those who can see the longer-term trends clearly.
The utilities index and the high-yield index both show returns over the past 10 years that were slightly more than twice as great as the FTSE All-Share index and an index of medium term (5-15 year) gilts. They both returned around 7 per cent a year - which in real terms (allowing for 2.5 per cent inflation) is slightly lower than the long-run average for shares and well above the long-run average for gilts.
Although I have not gone back to look at the way pundits were making predictions at the time, there were precious few in my memory who were urging clients or readers to stick to gilts and utilities. It may be relevant that only a handful of funds classified as UK asset allocation funds on the UK funds database performed better than either the All-Share or gilts indices over the 10-year period. Most of those were income funds; that is, funds whose portfolios were primarily chosen on their capacity for generating income from either dividends or bonds.
Just 15 out of 88 global asset allocation funds managed to double their investors' money over this period. Only about one-third of actively managed UK equity funds, meanwhile, managed to outperform the gilts index over 10 years.
Given the higher risk of equities, this was a less than brilliant performance, though it was in line with the long-run averages for actively managed funds. The best two funds over 10 years, I am happy to say, are Giles Hargreave's Marlborough Special Situations fund and Anthony Bolton's Special Situations fund, both of which are no strangers to this column.
In hindsight, the performance of gilts and utilities makes sense, because we can see that what we have lived through in the past 10 years is a prolonged period of disinflation (and hence of falling interest rates) that took investors at large a long time to realise was a structural, not temporary, change.
You can argue about just how predictable that trend may have been (although anyone who picked up on Roger Bootle's book The Death of Inflation would not have missed it), but not about the predictability of the returns from gilts and utilities that would follow if it proved to be correct.
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