I’ve been giving some talks on investment on the MoneyWeek cruise from Venice to Mykonos. I’ve learnt a few things.
First, cruising isn’t just for old people (the younger members of our party were clearly having what they would call an epic time).
Second, all-inclusive holidays make good sense when the champagne is part of the deal.
And third, however successful they have been in other areas of life (the cruise attracted a remarkably impressive audience), non-finance professionals still find investment trickier than I think they should.
You can see why. Chats with some of them revealed that most had had a disappointing experience with the advice industry of one kind or another – all too many told of portfolios clearly put together by advisers obsessed with complication and commissions; all too few had a focused portfolio of either passive or sensibly run active funds (they do exist!).
At the same time, just like almost everyone else, they were often baffled by jargon, tax implications and almost everything to do with pensions.
Not everyone has a high opinion of the financial services industry, but listening to our cruisers, I think you do have to give it huge credit for one thing: it is, I think, unique in having somehow persuaded vast numbers of generally intelligent people that its basic business is akin to an advanced form of rocket science, when it just isn’t.
One of my favourite analysts always refers to equities as nothing more than the small “sliver of hope between assets and liabilities”. He’s right, of course; but add up all the slivers in the market and you will find that over time, buying that hope can do wonders for your wealth.
On the boring bit of the cruise (the journey between Dubrovnik and Mykonos) we amused ourselves by looking at a chart of the performance of all the major asset classes over the past 200 years. The line tracking equities soared way beyond the rest – the best you got from pretty much everything else was the maintenance of the value of your capital in real terms. Equities gave you a return of 6-7% a year.
Now, you can argue the case here. Any type of indexing of this sort is riddled with survivor bias. The stocks in question won’t have been constant – the rubbish ones will have fallen by the wayside and been replaced with new ones. The same bias will be evident in the location of the equities in question. If you want to make a really long-term chart you can only do so with the US and UK markets. None of the others can show the data (wars, political collapses and late developers make it just too hard to gather).
So it isn’t that all equities and equity markets do well in the long term, it is that those that have survived have done well. Obvious, but important. There are also big arguments over the data used to create the 200-year chart – the indices that market historians have reconstructed to use for comparison purposes aren’t necessarily representative of most investor experience and finding early yields to compound has a high level of guesswork built in.
Then we have to note that the line doesn’t pay tax on every bit of income earned. Let’s not forget that almost all the returns from equities come in dividends. Without them the equity line would be as flat as the bond line on the chart. It doesn’t pay transaction costs either and it doesn’t get hit with capital gains tax. Charities – with their permanent capital and tax-free status – can look at the 200-year chart with some satisfaction. But the rest of us, with our frequent asset-destroying tax points (IHT, income tax and CGT for starters), should know our own compounding won’t be quite the same.
Finally we should remember that there aren’t many of us who are free to consider 200 years to be a reasonable investment horizon – in the main we tend to be looking ten or 20 years out when we invest. Over those shorter periods equities are a lot more volatile in their returns than they look on a nice smooth two-century chart.
But to me the 200-year line and the long list of criticisms of it makes investing rather simple. The key is just to behave in such a way that keeps your returns as close to the line as possible.
That means you want to keep your costs down (in terms of both fees and tax). You want to make sure you get paid and that you reinvest dividends (if you don’t reinvest, the magic of compounding can’t make you rich). And most crucially of all you want to invest most of your money in regions and companies you reckon will be survivors.
How do you do all this? In his latest letter to the patient shareholders of Personal Assets Trust (a very defensively set-up investment trust of which I am fond) Robin Angus refers to the joy of compounders. These are typically “long-established, tried and tested businesses” with strong franchises, conservative balance sheets, positive free cash flow, good dividend records and a corporate culture that recognises that the company’s business is not to “aggrandise and incentivise” its directors but to grow and manage the business in such a way as to enhance shareholder value over the long term (mainly by paying out dividends).
Compounders may not be the most exciting short-term investments there are. But they are more likely to be survivors than most. Funds that understand this would include Personal Assets but also several of the other funds I’ve looked at here in the past – Fundsmith, Kennox, Finsbury Growth & Income and the like.
However, as I know some of you are interested in Brazil this week I have also had a look at the Findlay Park Latin American Fund. It isn’t as cheap as I would like (the annual management fee is 1.25 per cent) but it has a clear bias towards what I am now going to call survivor stocks and what they call “best of breed” – investments in companies with all the characteristics mentioned above, bought at reasonable prices (the average price/earnings ratio in the fund is around 15 times) and traded very rarely. It has worked over the past five years (the fund’s net asset value is up 125 per cent) and, while there will be wobbles, the lesson of the 200-year chart is that if they stick to the strategy it will probably work over the next 15 too.
• This article was first published in the Financial Times