In the sector press
Value for Money
Kate Rogers, Portfolio Director and Head of Policy at Cazenove Charities shares her thoughts on issues faced by the charity sector in Third Sector Magazine every other month.
We all seek to spend our hard earned pennies on things that we believe offer us good value for money. Whether researching the best washing machine on Which? or evaluating the impact of our charitable spending; we seek for reassurance that what we are spending our money on is giving us the best outcome.
So what is value in investment management? We recently asked our pension fund clients for a 'tweet length' definition of value for money and received an amazing response. Our judges liked the simplicity of 'the amount you would be happy someone charging your mum', but the entry that I think encapsulates the challenge of finding value for money in investment management is 'you know what you are paying and believe it is worth it'.
This too can be applied to choosing individual investments. In fact, at the risk of being accused of overstatement, I believe that value is the most important metric in equity investment. Why? Well, looking back over almost a century of UK market data it seeks to answer a crucial question, in a world where everything keeps changing – politics, economics, the companies that we can invest in – what can investors look to as a constant?
It turns out that we are that constant - human beings - markets are cheap when we are fearful; and they are expensive when we are greedy. Appraising value is how we can help adjust our investment decisions to recognise these behavioural biases. When you buy an equity, you are buying a share in a company. In this context, value could be measured as the price of the share relative to the earnings that the company is making (referred to in 'city speak' as the P/E ratio). Analysis of history tells equity investors that, whatever people may think will determine whether or not they make money, the one thing that actually made the difference was the valuation that they paid. Every time the market fell to a P/E ratio of between zero and 7x, you would have made, on average and after inflation, 11% a year for a decade. The small print is that every time the market was at those levels, there was something so scary going on that you would have had to force yourself to buy. But, if you did, you were handsomely rewarded.
Whenever you paid a higher valuation, however, you would have seen a correspondingly lower return even if the price was entirely justifiable by good logic; better business? higher growth? world-changing new technology? It didn't matter, even if it turned out you were right about the outcome. GlaxoSmithKline undoubtedly had high growth 10 years ago. Did you make money in Glaxo? No. The internet undeniably changed our lives forever. Did you make any money in internet stocks? No. The lesson here is that even if you know the future, it will not determine the returns you make. What will, however, is the valuation that you pay.
A version of this article first appeared in Third Sector in August 2015. For this and other articles by Kate Rogers, visit thirdsector.co.uk
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