The truth, the whole truth, and anything but the truth on shares

Anthony Hilton12 April 2012

THE selling season for ISAs - individual savings accounts - is upon us and fund managers, after two years of falling returns, are preparing advertising campaigns to persuade shell-shocked small investors it will be third time lucky.

As usual, the old saw is being wheeled out that equities have spectacularly outperformed other investments over the very long term. But according to fresh research from the London Business School, those returns have been shamelessly overstated.

In Britain, research originally done by the old City firm of de Zoete was for decades the bible for compilers of long-term equity returns. It found that average real returns from UK equities were a mouthwatering 8.8% in the period 1919 to 1955. Great story, but sadly not true.

After rooting about in ancient copies of the Financial Times going back to Victoria's reign, LBS's Elroy Dimson, Paul Marsh and Mike Staunton say long-term stock market returns were in fact much lower.

First, de Zoete's choice of a starting date of immediately after the First World War flatters the figures because prices then were uncharacteristically low. Second, the number-crunchers ignored some of the worst-performing industrial sectors. Third, they fell victim to a common statistical error - 'survivorship bias'. They chose their basket of UK stocks from the biggest companies in 1935 and then looked at how they had performed over earlier years. By definition, investment duds were not included and the basket did rather well.

For their new book Triumph of the Optimists, the LBS trio looked at reported share market returns in 16 countries and found a similar bias in most. So average share returns are much lower than we have been led to believe. And that's before tax and dealing costs, which are excluded from these calculations.

They estimate that a more accurate average annual real return for the entire 20th century is 5.8%. That still emphatically beats bonds (1.3%) and cash (1%), but the difference with the de Zoete view is gaping: £1,000 invested over a century at 8.8% delivers £4.6m; at 5.8% it produces £279,000.

Even 5.8% may well overstate things. It is hard to see how average real share market returns can grow any faster than the overall economy over the very long term. For Britain, that means average real returns of 2.5% or so.

The late 20th century may come to be seen as an exceptional and unrepeatable time for shares. Certainly investors, grown blase about double-digit returns, need to lower their expectations drastically. And fund managers and sellers of ISAs should tone down their ads rather than risk selling what they rarely deliver.

Cruel rule

PEOPLE in the City who are fed up with London's rules should cast an eye over what is coming at them from Brussels in the form of market abuse proposals being drafted by the European Commission.

In particular, they should note how these will apply to commodity derivative markets, a world far removed from equities. In the commodity markets there are no listing requirements and no obligation on users to provide the market with information - key elements of the equity system.

So if an oil company has a problem in a refinery which means it cannot meet demand, it can go quietly into the market to buy the replacement stock it needs. But the market abuse provision would seem to class that as insider dealing. To avoid a charge of market abuse the oil company should first tell the world its refinery is on the blink and then, but only then, go into the market to buy replacement stocks - at the suitably inflated price.

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