Investment history is a tale of gains and losses, with hopefully some lessons that can be used today. At the end of last year we had an example of the very long term rewards from investing in the auction of Leonardo da Vinci’s painting of Salvator Mundi for $450 million. In the Wall Street Journal, columnist Jason Zweig made an attempt to quantify the painting’s financial return from its first sale through to 2017. By his calculations, after taking into account inflation, the annual return since the sixteenth century was 1.35%. For comparison over a shorter period, the gain after inflation since 1871 in the US stock market averaged 6.9% per annum. Closer to home, how about footballers now being bought and sold for £100 million? Isn’t that ridiculously expensive? Well, not if you adjust prices for inflation as measured by reference to the amount of television money that has poured into the beautiful game over the past 20 years. In TV money-adjusted terms, it shouldn’t be long before the cost of a top Premiership player hits £300 million. What price Sir Bobby Moore today?
We’re not saying you have to wait for a century or more before seeing gains in your portfolio, but whether we like it or not we are all risk takers anytime we get out of bed or cross a street, let alone make a long term investment decision. Any portfolio’s strategy can be summed up as capital preservation or capital appreciation or for most, a combination of the two. In the above model of comparative returns to the value of Salvator Mundi’s portrait, it is important to note the better performance of the painting over cash kept in the bank. This highlights the risk of investing in “safe” assets. Cash is not protected against inflation, particularly the virulent type that has been seen periodically through history. Obviously not every single risk works out for long-term investors, but many do. The key for private clients lies in the careful selection of a blend of leading, well diversified funds that hold several different types of assets.Buy well and then do nothing, as patience is the key to long term success. Don’t chase short term performance however tempting that might be, as most of the top performing fund managers have had periods of up to three years at a time when they don’t keep up with their peer group or the market. Investors without advisers often tend to sell funds when they are at or near their lows and buy in after a run of good returns. If you can’t resist the temptation to fire good managers when they are down it is probably best not to try as you are likely to underperform the market.
We recognise that investing involves the risk of capital loss and that this can be worrying. However, the advice when share prices take a tumble is always: “Don’t panic, take a deep breath and recognise that this was due to happen sooner or later.” Indeed, it is our opinion that stock markets are overvalued at the moment. Our research covering decades' worth of data points to the conclusion that, broadly speaking, the ratio of companies' share prices to their profits – a common measure of equity valuations – is quite a bit off-balance. In other words, equity markets seem to have run ahead of themselves, which is especially true of the US market. This happens from time to time. And, although past performance is not a reliable indicator of future results, a short-term correction is usually nothing to be seriously concerned about. The best course of action will likely be no action whatsoever. Have a nice cup of tea and let others worry about the news headlines from the City of London, North Korea, Wall Street or Trump Towers.
Now on to a topic mentioned more and more by clients, the march of the robots.Are computers, artificial intelligence and robots about to make us all redundant? Well, no actually. Automation may even make our working lives more human. Machines are doing more and more of the work that used to be done by humans. Data from the US Bureau of Economic Analysis show that the amount of technology used per unit of production doubled between 2001 and 2015. There's no reason to believe this trend will slow down any time soon. Studies conducted by the World Bank and the University of Oxford estimated that 70% of jobs in India, 75% in China and 50% in the United States could be automated within a decade, meaning hundreds of millions of people could find themselves out of work. Those statistics paint a bleak picture of the future, but we should remember that tasks are not jobs. Many of us spend our workdays on basic tasks including recording, assembling, inspecting and processing information. Much of this work could easily be replaced by computers. However, more advanced tasks such as problem-solving, strategising and thinking creatively will be the preserve of humans for the foreseeable future. Regardless of how smart computers become, humans will have a comparative advantage in performing them. Every single occupation studied has moved up the ‘task complexity’ ladder, meaning that for the vast majority of workers, automation will continue to elevate their jobs by eliminating some of the tasks they don't want to do, allowing them to spend more time on engaging ones. In an irony that will surprise pessimists, robots will make our working lives more human.
Productivity (the measure of how much output is produced per worker per unit of time) often receives publicity in the media. Experts have been trying to improve our productivity for decades without much success. We have tried industrial strategies, deregulating markets and tax breaks. The education system has been reformed and re-focused on providing the skills business needs more times than most people can count. Despite that, productivity has remained stubbornly flat. There has been a small improvement recently; nevertheless it still needs to grow much faster to keep our living standards rising. The economist Robert Solow once quipped: ‘You can see the computer age everywhere but in the productivity statistics.’ Right across the developed world, vast sums of money have been poured into IT, the internet and computing, but unlike other waves of technological innovation, from steam engines to electrification, none of it seems to have made us produce more per hour. But the new wave of technologies may finally be about to help us out. We read a lot about robots destroying our jobs — but perhaps they will just make us better at them and more productive as well.
Next, should investors hold Bitcoin? For our readers who haven’t kept up with the latest financial fad, Bitcoin is what is known as a ‘cryptocurrency’. More helpfully it is a peer-to-peer electronic cash payment system that does away with the need to hold money created by central governments. There are other cryptocurrencies available, but Bitcoin is the one that attracts most of the attention. Its price per coin has risen from around $1,000 a year ago to $10,000 at the time of writing, so you can see why people are talking about it. Having said that, the price actually rose to nearly $20,000 just before Christmas, so you can see the risk and the volatility. Many investors have lost their shirts in a matter of days as they bought at the top of the market and then panic sold when prices fell by a few percentage points because they can’t afford the losses. Hubble, bubble, toil and trouble indeed.
In our opinion, investors are far better served focusing on investing in companies that are seeking to profit from the development and adoption of the financial technology behind cryptocurrencies. As a medium of exchange, cryptocurrencies are a solution in search of a problem. Visa processed an average of 4,500 transactions per second in 2016, while today it is estimated thatBitcoin can only process up to five transactions per second. In China, the rise of mobile phone–based payment systems WeChat Pay and Alipay, neither of which currently involves cryptocurrencies, has already driven a shift in China away from cash and credit cards as the preferred payment methods, processing an estimated $5 trillion in transactions in 2016. It is therefore hard to see how cryptocurrencies can ever become a widely accept medium of exchange. As the old adage goes, in a gold rush the real money is made by selling picks and shovels.
When we are introduced to a potential new client they sometimes ask us where is the logic of using a smallish firm like Scholes & Brown when they could have their money managed by a much bigger outfit boasting 300 economists at head office and assets under management of several billion. Well, choosing a large ‘wealth management’ company often results in the client being shoehorned into an inflexible system which can mean you become a very small cog in a great big wheel, with no access to anyone who can give you satisfactory answers to your quite reasonable questions once you have signed on the dotted line. Capital is often spread over a huge number of individual holdings, many of which are tiny – alright for an institution with hundreds of millions invested but no use at all for private investors. In addition, holdings can be bought and sold almost daily, at considerable cost but (as far as we can see) to no good purpose. The end result? Inferior returns after charges for the poor investor and a lot of worry and bewilderment too. We get frustrated when such things happen. The financial world is confusing enough for the private investor as it is. So many products, so many enticing advertisements, so much gobbledegook – and all at a time when so many of the old certainties seem to be slipping away.
Next, we are sometimes asked what is a reasonable rate of return to expect from your portfolio? Well, that depends on the amount of risk you are prepared to take, your timescale, the price you paid for the investments, where the capital is invested and the effect of charges over time. One useful way of calculating the total return you can expect from equities starts from the observation that the capital value of a share tends to grow in line with the dividends on it. Therefore, because dividend growth on equities as a whole will reflect both the inflation rate and the growth of the economy, so will the capital value of equities. You can therefore work out your likely long term total return from equities by taking the typical yield on the UK equity market (3.5%) and adding to it the average long term inflation rate (2%), plus the rate of growth in GDP (2.5% from 1956 until 2017). In total, this gives us an expected return from a share portfolio of 8% per annum. Naturally individual portfolios will perform better or worse than this according to where the money is invested and the prevailing economic conditions and outlook at a given time, but 8% is a realistic figure with which to start.
Overall we seem to be entering the latter stages of the bull market that has persisted since 2009. With global growth picking up and interest rates still suppressed it is too early to be leaving the party, but most of our carefully chosen fund managers are now reducing the risk in their portfolios. The BBC continues to harp on ad infinitum about the end-of-the-world that is Brexit, but we have always said that, in 20 years, Brexit will be seen as having been as important as a pimple on a teenager. Similarly, whilst we wouldn’t want to go into business with Mr Trump, good people often don’t make successful politicians. And vice versa. At home, Theresa May continues to disappoint and the rise of Jeremy Corbyn now seems irresistible.Mrs May should remember that management is about doing things right, but leadership is about doing the right things.
Penultimately, we are delighted to announce that we have a new Technical Analyst who joined us this month from Coutts – Gershom Chan. Gershom’s details can be found on the About Us page on our web site and he will be moving among you shortly. You may also notice that the writer has discovered the secret of eternal youth – never update your photograph on your web site.
Finally, the heading: “I don't know what it is that I like about you, but I like it a lot” refers to an early Led Zeppelin track. You will know that the innovative style of guitar playing used by Jimmy Page on this song has been widely copied by many famous rockers over the years. In this instance we would like to use it to ask clients what, if anything, you like about Scholes & Brown and, more importantly, what you don’t particularly like. We want to know what we should be doing more of and what we should try to reduce or even eliminate, subject of course to regulatory constraints.Please let us know and don’t be afraid to hurt our feelings.