Outlook: Another failed transformation as Six Continents does splits

LSE clanger; Gilt/equity returns

Institutional shareholders are said to have played a crucial role in bringing about the demerger of Six Continents, but you have to wonder whether it was worth the bother. The listing particulars for the two new companies sent to shareholders yesterday show the total cost of the exercise to be £109m.

This is a high price to pay for an exercise which holds no guarantee of a rerating. It is all very well citing the extra "focus" that will become possible for management once the company is separated into a hotels company on the one hand and a pubs and restaurants outfit on the other, but if management remains the same, it's unlikely to make much of a difference.

The Six Continents of today is the result of a wholly pointless exercise in corporate transformation. Actually, it was worse than pointless, it was value destructive. Fast back to the mid 1980s, when Bass was plodding along as Britain's biggest and most successful brewer. Then came the beer orders, which required such companies to become either brewers or pub owners, and Bass seemed to lose the plot.

Barred from further consolidation of the British brewing market by its already dominant market share, Bass instead chose to diversify away from brewing, chiefly into hotels, where it bought the Intercontinental and Holiday Inn chains at what seem today like extraordinarily high prices. The only decent thing that can be said for the strategy is that the company secured a relatively high price for the breweries by persuading Interbrew it was worth the regulatory risk of attempting the consolidation Bass itself had tried and failed to secure.

All the same, Bass's chairman, Sir Ian Prosser, would have done much better to have stuck to his knitting by pursuing the opportunities for international expansion in brewing that were beginning to open up by the mid-1990s. Attempting to transform the company into a hotels and leisure group was a costly mistake, of value only to the bankers and advisers that did the deals.

The demerger at least divides the company up into bite sized chunks for the private equity and trade buyers already circling the dying carcass. I risk another screen full of e-mails from hot under the collar chairmen and chief executives for saying this, but Bass is yet another example of the urgent need for Higgs, or something else capable of protecting investors from the consequences of ill thought out, high risk strategy.

When managements expand into businesses they know little or nothing about, it nearly always profits their investors nothing and very often ends up costing them an arm and a leg. The Higgs proposals on non executive directors may not be right in every particular, but something has to be done to bring the disciplines and focus of private equity to bear on the publicly quoted sector, or soon there may one day be no publicly quoted companies left to invest in.

LSE clanger

The London Stock Exchange has almost certainly over reacted by publishing such a strongly worded denial of what it says is just a lot of malicious nonsense. All it has succeeded in doing is giving legs to a story that nobody with any knowledge of Clara Furse, the stock exchange chief executive, would have believed in the first place.

But for the statement, the allegations would never have left the pages of the Mail on Sunday, where they first appeared. Now readers of all the main broadsheets and tabloids are left to speculate on what the "outrageous slur" about Clara Furse's private life was that was so libellous it could not be printed, and on the basis that there is rarely any smoke without fire, they may well conclude the wrong thing.

At the very least they are going to believe Ms Furse the victim of a reactionary plot by male, City stuffed shirts. This seems to me just as unlikely as any of the alternatives, but whatever the truth, the Stock Exchange has certainly ensured that tongues will wag for weeks to come. All this is assuming the LSE has got its facts right.

The LSE was meant to have swapped its status as pillar of the City establishment to that of just another publicly quoted company when it floated on its own exchange a year and a half ago, but it seems to have lost none of its propensity for shooting itself in the foot.

Gilt/equity returns

It seems like only yesterday that stock market cheer leaders and overly optimistic economists were writing in starry eyed rapture about the delights of the "New Paradigm". This was the idea that a combination of technology and globalisation had allowed a golden age of above trend, inflationless growth to dawn, making it possible for the stock market to justify much higher valuations than had been possible in the past. We all know what happened next.

The paradigm that now seems to have established itself is the very reverse, with Western economies said by some to be set for years of below trend growth, stagnant or falling prices, and companies struggling to grow either profits or dividends. In the "New, New Paradigm", even today's depressed equity valuations are hard to justify and shares will continue to fall. For those interested in what these trends mean for investment, Credit Suisse First Boston's annual Equity Gilt study, published tomorrow, will make instructive reading.

The study is a backward looking exercise, so unfortunately it tells you nothing about the future, which is as unpredictable as ever. None the less, there are some startling findings. One is that the past 10 years is the best ever for UK gilts relative to equities and for the past three years, the worst ever for equities relative to gilts. It is a statement of the obvious that gilts have hugely outperformed equities this past three years, with the two asset classes moving in opposite directions. Less well appreciated is that the bear market in equities has succeeded in reversing some longer-term assumptions too. Gilts have produced a higher rate of return than equities on a 10, 15 and very nearly 20-year view as well.

For those tutored in the cult of equity – the belief that in the long-run equities will always outperform bonds – this is an eye opening (and watering) finding. If you want to know why your pension plan and other saving products have gone down the pan, this is the explanation. Investment managers simply got it wrong in continuing to invest in equities. They should have looked at falling inflation and interest rates, and gone for bonds instead. The reason they didn't, to use one of Warren Buffett's favourite analogies, is that their eyes were too much fixed on the rear view mirror, rather than the road ahead. They allowed the past to instruct their future.

As the cult of bonds re-establishes itself, is there not a danger of the same thing happening again – that we won't recognise the next paradigm shift, when the relationship between gilts and equities reverses back again, until it is actually upon us?

Personally I'm quite taken by this view, even if I go along with those who think gilts and equities might continue to move on their present trajectories for some little while yet before a more conventional relationship is reestablished. The cult of equity may not yet have been sufficiently trashed to allow a revival. All the same, Western governments have begun printing an awful lot of money again in an attempt to counter the downturn in the private sector and keep their economies afloat. Eventually, this is likely to prove inflationary. Remember, it only requires the yield on a 10-year gilt to rise from the present 4.25 per cent to 6.25 per cent to be a third down on your capital. It seems to me the chances of this happening are rather higher than that equities fall another third.

However, I'm leaving myself a long ladder down which to climb. The yield on a 10-year Japanese government bond is less than 1 per cent, which just goes to show there may be a lot further to go before the trends reverse again.

jeremy.warner@independent.co.uk