The risks of investing in the 'new nifty fifty'

Times are tough for fund managers. All the uncertainty is making it really hard for them to find an investing theme they can both explain easily to potential investors and defend against all comers.

Banks don't work (too uncertain); commodities don't work (prices are coming down); emerging markets aren't so easy any more (what if China has a hard landing?); and, of course, UK and US stocks as a whole look a bit risky for the price. Tricky.

It is with obvious relief, then, that the industry has finally landed on something that looks like it is going to work. I've been suggesting here for some time that you invest into high quality, reasonably high yielding stocks with solid balance sheets and good dividend cover. I've hardly been alone of course the likes of Invesco's Neil Woodford and Troy's Sebastian Lyon have been all over the idea as well.

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But now everyone's getting on the game. Almost all managers I interview now (and there are many) tell me that there is one thing they are looking for above all else: quality and consistency of earnings.

Their portfolios are all about stocks that can hold their own in times of deflation and inflation; that have exposure to growing emerging market economies; and that as a result can do well regardless of whether Western GDP is rising or falling. "Quality companies exposed to growth markets," as Murray International's Bruce Stout summed it up for me.

Then they quote much the same companies. Think GlaxoSmithKline (GSK) (which I hold myself), Nestle (NESN), Reckitt Benckiser (RB), Unilever (ULVR), Tesco (TSCO), AstraZeneca (AZN) and Vodafone (VOD).

While I was off last week, this trend finally got itself a name, courtesy of Morgan Stanley's Ronan Carr. From now on, any stocks that look like they can deliver good, transparent and steady growth look like they are going to be known as the 'new nifty fifty' (or, perhaps, the NNF).

This all makes sense. The 'nifty fifty' of the 1960s and 1970s wasn't a precise list, but the name was applied to a group of stocks that regularly outperformed by around 180%, depending on what you include from 1964 to 1972.

They were much loved for the same reason our NNF stocks are about to be: they offered regular above-average earnings growth and they never cut their dividends even in what was a pretty bleak time for the economy as a whole. That kind of thing is as attractive now as it was then. After all, in a time of low growth, low returns and negative real interest rates, why wouldn't you want to hold stocks that promise a consistent return?

You might even look at some of the dividend payers and think that they were offering you something of a sovereign bond substitute just with lower default risk, given that the average big company is significantly more cashed up than the average government. You also might think that you'd pay a pretty good premium for that kind of thing: the more certain the earnings, the more they are worth in otherwise uncertain times.

But the question is just how much more you would pay. Back in the 1970s, the answer was the moon. By late 1972, Avon was trading on 62 times earnings, Xerox was on 49 times, and poor Polaroid was on 91 times. Then they crashed by 86%, 71% and 91% proving to all those who claimed price didn't matter as long as you got quality that they were absolutely completely and utterly wrong.

It turned out- as academics at Pomona College in California note- that, as with everything else, there was "a substantial and statistically persuasive inverse relationship between p/e ratio and subsequent long term performance". Buy overpriced assets and you'll lose money. Simple.

I am not saying that you shouldn't buy today's NNF you probably should. They aren't expensive. Large German and French corporates are even trading near 30-year lows in terms of their cyclically adjusted p/e ratios, which seems to me to be a pretty fabulous long-term buy signal. It also makes sense that there should be a good premium on quality stocks. Right now there isn't.

Finally, there is momentum building behind the story something that should keep it going for a while.

As you buy, though, you need to remember the risks.

First, many of the obvious members of our NNF are already operating on very high profit margins which makes them more likely to fall than rise.

Second, they have political risk written all over them. Governments don't have cash. Quality corporates do. Even now there will be a dedicated group at the Treasury, hands to heads as they try to figure out how to shift it from the latter to the former.

And third, the NNF is such a good story that you might find it hard to sell when you really should.

So, if you do buy in, do yourself a favour: write "Polaroid" on a Post-It note and stick it on the edge of your computer before you call your broker.

This article was first published in the Financial Times