A look at strategy in the long term

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The Independent Online
If today's competition review by Michael Heseltine does indeed criticise the City for the short- term focus of its investment horizons, ponder on the fact that one of the City's largest investment houses is looking at the most appropriate investment policy for the period up to 2000.

Since 1991, BZW has sought to set out just such a long-term investment strategy, identifying the long-term trends that ought to guide investment.

Each year it modifies its view on the basis of the new evidence at a global strategy conference, and then it publishes the results in an investment circular, Strategy 2000.

This a good discipline for two reasons. First, it is always helpful to identify why particular investment decisions can or cannot be justified by fundamental economic factors - if one is going to invest for tactical reasons in a region or a sector where the fundamentals are running in the wrong direction, at least it is nice to identify the risks involved.

And second, by taking a six- or seven-year time horizon, there is a reasonable chance that even if one gets the timing of entry wrong, the underlying good performance derived from the fundamentals should ensure that the investments come right in the end.

BZW sets out seven broad factors it believes will govern investment in the 1990s - living standards rising at a faster rate than in the 1980s, no price stability but inflation not a problem, commodity prices rising in real terms, greater concern about current account imbalances, 'knowledge intensive' industries preferred, cost of capital having a greater importance in competitiveness and direct investment targeted on emerging economies.

Each year it reviews these. Most are pretty self-explanatory, but the one that might cause the greatest surprise among people outside the investment community is the first. BZW has stuck to this view despite the early 1990s recession.

It is based on two factors, an upturn in the long-run innovation cycle and an improvement in overall productivity.

BZW believes that companies are getting better at using capital stock more efficiently, with the effect that both labour and capital productivity are rising faster than before.

BZW then loosely applies these factors to the various economies, ranking them in terms of their attractiveness as investments. It makes judgements about growth, demographics, inflation, sensitivity to commodity prices, the openness of the economies, their 'knowledge industries', whether they receive much inward investment, and their cost of capital. Overall, the most attactive countries for investment are the three Nafta countries, the US, Canada and Mexico, plus Australia and New Zealand. They are followed by the UK, France, Sweden and Venezuela.

The most unattractive countries are Japan and Hong Kong, followed by Korea and Italy.

The most obvious general point is that in the developed world the 'Anglo' countries do much better than the continental Europeans or Japan, and in the developing world Latin America does better than East Asia. This runs counter to popular perceptions of economic advantage and, if it is right, perhaps people need to think further of the nature of comparative advantage in the future.

The worst score by far is that for Hong Kong, which has been one of the fastest growing economies in the world. Perhaps its great run is drawing to a close.

The scoring seems to work in investment terms. BZW has tracked back an equity portfolio based on its recommended market weightings since December 1990 and the portfolio does perform significantly better than the FT world stock market index - by 15.1 per cent in local currencies and 11.6 per cent in dollars. Of course, what works in the past may not work so well in the future.

There are certainly individual results that will have pulled down the performance of the portfolio.

Being underweight in Hong Kong means that the BZW recommended portfolio will have missed out on an extraordinary boom. But it will also have missed the investment catastrophe of Japan.

BZW choses equities for this exercise rather than fixed interest securities because it believes these will outperform bonds in the longer term. But it also makes a tactical assessment, looking at bonds and currencies as well as equities. This gives slightly different results, for example upgrading Korean equities and downgrading German bonds and the yen.

All in all, though, it is an exercise that serious investors should follow. They may reach different strategic conclusions from BZW. But they would at least be making a set of long-term investment judgements based on a disciplined assessment of the underlying strengths and weaknesses of the various economies.

At the very worst they could assure themselves that they had been wrong for the right reasons, and they would have demonstrated to the President of the Board of Trade that not everyone in the City believes that a long-term view means after lunch.

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