equities are my preferred asset class renouf

George Renouf details his argument that quality companies will adapt to whatever economies throw at them so equities are still his asset class of choice.

equities are my preferred asset class renouf


Despite the summer success, all that glitters is not gold. The London 2012 gold medals for instance are only 1.3% gold, 92.5% silver and the rest copper. Clearly cost is a significant factor as it would have cost $6.8m to hand out all 302 gold medals if they were solid gold – instead the sum was much more modest at $145,000.

Reliance on gold

However, if they were gold would they be a good investment for the athletes who defied the odds to claim them?

Gold has become a much more traded asset with the introduction of ETFs. However, its formal pricing history goes to 1717 when Sir Isaac Newton, as Master of the Mint, first set the official UK gold price at £4 8s 9d per troy ounce. Here it remained for 200 years and the last time I looked it was a touch over $1,600.

According to the World Gold Council the price increased by 394% in the ten years to October 2010. Current demand remains high underpinning prices with total central bank gold purchases in the second quarter more than double one year earlier, as emerging market governments sought to diversify away from traditional reserve currencies and developed markets’ government debt.

A very impressive return in nominal capital terms if you held gold for those ten years but pretty uninspiring if you held it from 1935 to 1971, and it does not take inflation into account.

If we factor in inflation, the return loses much of its lustre. Since the 1950s gold has kept pace with inflation, but only just, with an average annual real return of around 1.3%.

A relative game

How does this stack up against other asset classes over the longer term? The calculation for this presents some challenges in itself. The FTSE 100 Index did not come into existence until 1984 and although we have had a FT30 Index since 1935 it bears little resemblance to what we use today.

Corporate bonds also present some difficulties because many of the early listed issues went into default. It is relatively easy to compare returns of the UK gilt market as it has been in existence since 1693 with readily available data.

Today the UK government has around 70% of GDP outstanding in gilt issuance which is relatively modest when compared to the 250% reached during Napoleonic Wars in 1815. 

When comparing returns from UK equities, corporate bonds and UK gilts since the 1950s there is a clear winner. Equities, with an annual average real rate of return of 6.6%, gilts returned 2.2% and corporate bonds 1.8% on the same real return basis. US equities over the same period returned 5.6%.

Given that the FTSE 100 is at the same nominal value as it was in 1998, 2001, 2005 and 2009, it is worth emphasising that even over this period equities have outperformed gilts; 4.6% versus 3.6% on a real annualised return basis.

Further evidence can be seen in the investment trust global growth sector which has returned 109% on a total shareholder return basis over that period, showing that active managers, even in a flat market, can produce meaningful investment returns for shareholders.
What is also important is to highlight the effect of compounding of dividends.

One hundred pounds invested a hundred years ago in a reputable investment trust would be worth around £100,000 in today’s money. Had the dividends been reinvested it would be worth over £10m. Even adjusting for inflation it emphasises not only the power of compounding dividends but more importantly the superior return from equities over the long term.

What about the prospects for future returns?

According to the IMF, global growth will be positive this year and next; 3.5% in 2012 and 3.9% in 2013. These numbers have been revised down over this year, and as the IMF report notes: “Downside risks to this weaker global outlook loom large. The most immediate risk is still that delayed or insufficient policy action will further escalate the euro area crisis.”

The other key region is the US which still accounts for more than 50% of global output, and their concerns there are that “…the main risk relates to the possibility of excessive fiscal tightening, given recent political gridlock”.

On the upside, the slowing of emerging market growth since mid-2011 has been partly due to policy tightening in response to unsustainably high levels of growth. This being the case, there are fiscal and monetary levers available to ensure current growth can be sustained despite events in Europe.

The emerging and developing economies are forecast to post growth of nearly 6% next year with China leading the way at 8.5%. I do not think these levels are sustainable in the long term but they are certainly welcome in the current environment and many well positioned companies will benefit from this.  

Can equities continue to provide superior returns in such an environment? I think the simple answer is “Yes”.

Equities are my preferred asset class and my rationale is embedded in the above statistics; you don’t need strong economic growth for equities to provide meaningful returns.

These returns are driven by two factors, dividends and changes in the value of the share. These in turn are not driven by GDP but by the individual companies’ underlying fundamentals and changes in earnings per share. Any index return is simply an aggregate of a large group of companies and by its very nature will include poor companies as well as good ones.

I am not saying that one can completely ignore the profile of economic activity in the global economy but good quality companies with proven management teams and governance will adapt to changes to economic circumstance and provide consistent returns throughout the economic cycle.

Pick the winners; it’s that simple – just like winning gold at London 2012.



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