time for some pespective

time for some pespective

February 24th, 2010

The recently published Barclays Equity Gilt 2010 study seemed to turn everything we know about risk on its head. In revealing the 10-year real – that is, inflation-adjusted – return from various different asset classes, it showed equities have dipped 1.2%, while corporate bonds have delivered the highest return, at 2.9% per year. Gilts added 2.6% per year. On this basis asset allocation should be simple. If risk doesn’t pay over the longer term, why take it? Stick everything in gilts and corporate bonds, collect coupons and never be troubled with the stockmarket again. Actually, given that cash paid 1.8%, is an extra 1% per year really the risk of investing in corporate bonds? If only it were that easy – but there are a number of reasons why it is not. Certainly, there has been a progressive de-rating of developed market equities over the past 20 years. One European manager recently said he could remember the time when high-quality, dividend-paying European blue-chips commanded valuations of 30x or 40x earnings. That has been progressively eroded. But investors should bear in mind that, 10 years ago, the UK was at the top of the technology bubble. The overall level of the market was skewed by a number of companies on valuations that were unprecedented and, rightly, have never been matched. A more accurate picture could be gleaned by stripping out the bubble stocks and focusing on what has happened to equities not caught up in that “irrational exuberance”. The de-rating would still be in evidence, but it would not be as profound. Equally, there is still one, big argument against using the study to determine future asset allocation. If the credit crunch has taught us one thing, it is that past performance is poor a guide to the future. Financial models suggested the credit crunch was a one-in-a-million chance based on past performance but it still happened. If in 2000 you had looked at the previous 10 years and projected into the future, every model would have told you that equities would have been the place to be for long-term returns. Yet … here we are. Investors have to be cleverer than that. At the moment, cash pays nothing. Few savings accounts even match inflation. Gilts look very expensive. They have been artificially supported by quantitative easing and it is difficult to know where support will come from in the future. Corporate bonds have had a strong run. Equity valuations, on the other hand, still look relatively modest compared to other asset classes and – for what it may or may not be worth – to their own history. If anything, these figures should suggest it is a time to buy, rather than to abandon, equities. For advice on Investments please call Mark or Clare at GMP Independent Financial Advisers LLP on 02072886400

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