Following in the footsteps of Danny Truell from the Wellcome Trust, David Swensen of the Yale Endowment, and Professor John Kay, we were delighted to welcome Professor Elroy Dimson to deliver the fourth annual Cazenove Charities Investment Lecture on 24th May at the Royal Institution. The theme of the talk was ‘lessons from the long term’ and he drew upon 117 years of data, gathered from 23 countries for equity, bonds, cash and inflation.
This vast data set shows how much things have changed over the decades. In the 1900s bonds were the main asset class, soon to be overtaken by equity markets, in what Professor Dimson termed the ‘triumph of the optimists’. Those early investors that believed in companies offering a share of their profits were rewarded handsomely, which is what equity holders and most long term charity investors continue to rely on today.
In 1900, the UK was the biggest equity market in the world, representing 25% of global equity market capitalisation compared to the US share of 15%. In 2017 however, as an aggregate, US listed companies are larger than the rest of the world combined, having leapt to 58% of the equity market – whilst the UK has shrunk to just 7%. Whole industries that once were hugely significant, such as railways, are now much smaller component of markets – whilst new industries, such as Information Technology, form the cornerstones of today’s investment markets.
There are clear parallels between today’s ‘stranded assets’ and the disappearing industries of the past. In recent investment memory, this term has been used to describe oil reserves owned by large oil companies that, because of global warming, may not be able to be burnt and may therefore be valueless. Professor Dimson compared this with the canals in the 19th century – assets that were fundamental to the transportation of goods until railways were invented. Canals still existed and were still used, but their relative importance had been significantly diminished, in other words they were ‘stranded assets’. Similar concept, different century.
It was also interesting to reflect on how the past has shaped our portfolios today. Modern portfolio theory talks of diversification, or not putting all your eggs in the equity basket. This was developed in the 1950s, when equity investors had only just recovered the value that was lost in the 1920s when the equity market fell by 75%. It took two decades to recoup the real value of assets invested in that period.
Professor Dimson shared three lessons from the past to help charity investors with long-term time horizons think about their investment strategies today.
Most people overestimate expected returns after inflation. Professor Dimson believes that we are now in a low-return world and are unlikely to benefit from a return to higher expected returns in the near term. Furthermore, history shows that contrary to popular belief, it is the companies in low-growth countries that tend to perform better than those in high growth countries. In his opinion, whilst equites are expected to offer inflation plus 3% to 3.5% per annum over the long term, traditional equity/bond portfolios would only generate inflation plus 2% per annum. This could present a challenge for charity investors seeking perpetuity and spending 3% to 4% per annum.
2. A long-term view brings benefits
Many charity investors benefit from an investment time horizon spanning several generations. Although some elect to ‘spend out’ if this is in the interests of their mission, most foundations benefit from an extended investment perspective and are able to capitalise on equity performance – with history showing equity investors are consistently rewarded over the long term. That said, it was noted that equities do not always act as a good hedge against inflation in the short term.
In a lower-return world, cost control is more important. With an increasing number of complex investment strategies available, investors must be conscious of the costs involved in investing in them. Although complex strategies may work, they can be expensive – and higher returns can be materially reduced by costs.
These three lessons from the past should help charity investors with long term time horizons think about their investment strategies today. Professor Dimson’s expectations for a more challenging return environment perhaps emphasises the need for active management to generate excess returns – whilst keeping a watchful eye on costs. It also highlights the importance of focusing on the long term, and avoiding being distracted by short term oscillations and noise.
The lecture was warmly received by representatives from well over one hundred charities and after an insightful Q&A session, attendees retired for drinks and canapés in the impressive surroundings of the library.