VALUE INVESTING
Pensions, Poor Performance And Property

By Stephen Bland (TMFPyad)
October 31, 2003

Why are shares attractive? A fundamental question and perhaps one every investor in the market should ask themselves. In one sense the answer is easy -- shares are attractive because investors see them as a way of making money. But in practice it may not be that easy to make money from shares. I am not convinced, as I suggested last week, that equity investors in general make much out of the market. In fact, I believe that a large proportion of equity investors never do and this applies to both direct and those investing via pooled funds and schemes of one kind or another.

I was listening to a financial programme on Radio 4 about how poorly large numbers of investors in unit-linked personal pension plans marketed by some well known companies had done over long periods. One chap gave the figures of how over ten years of regular contributions to a unit-linked personal pension invested in broadly based share funds, his plan was now worth less than he had paid in, a worse performance than both the US or UK stock markets in general. He didn't say so, but presumably the reason he chose equity funds rather than cash funds is that he believed the former would provide a better return.

Such stories abound. Think about it; this guy and a lot like him were investing in plans that were supposed to provide a pension via an annuity at the end of the day. He chose equity funds because he, for some reason, believed that these gave him best chance of making decent returns. Yet so incompetent are the insurers whom he trusted that he has lost money from a combination of excessive charges and poor performance. What sort of pension can he ever expect in consequence?

The joke, a bad one for the poor investors caught by such things, is that unit-linked plans were always supposed to have an edge over with-profits schemes because they were more 'transparent', meaning you could see the current value of your fund at any time, as against with-profit schemes in which the actual investments and their value at any particular point were unclear. Pension scheme cynics like me might, in view of how too many of these plans turned out, be excused for thinking that 'transparent' means merely that you can see how you are being ripped off.

Of course now it's different. Where have I heard that before?

Quite apart from chronically poor insurance company management often making things much worse, my view is that the whole risk of actually being in the stock market is seriously understated. To demonstrate this, I understand that the annual compound return on a tracker fund over the last ten years is only around 4% or so following the bear market. This is probably no better than cash and thus investors have not been rewarded for risk if they could have obtained a similar risk-free return from deposit accounts.

However, taking the FTSE 100 from inception in 1984 on a theoretical tracker, because none exist from that date, would give a much better figure of perhaps 9% which probably beats cash but not by as much as you might think, because cash returns were very much higher than they are now for much of the period. I can recall 10% secure interest from building societies for example. The risk premium, that is the additional reward over long periods for choosing general shares over cash, just does not seem to be sufficiently high.

These returns are a mere fraction of the return on London property, though I speak with hindsight. It is hard though to avoid the feeling that such property has generally been a much better investment than the stock market in general, aided greatly by the ease with which investors in the latter can gear up through mortgages. I remember even as a kid, which in my case is aeons ago, hearing from my parents of the distrust of the stock market and the belief in property. They were right.

Where I grew up, I recall when I was about 11 my parents bought a house for about £4,500. I recently discovered that similar houses in that street are now going for about £300,000. A familiar pattern in London and probably many other places too, but not everywhere of course. I doubt that any tracker, should one have existed back then, would have produced that kind of growth. The effect is that quite ordinary people are now seriously well off through property, something that is never going to happen to them with shares. I guess one of the attractions of property will always be that you can feel it, see it, use it, whereas shares can only ever be just trading counters, with individual equities capable of evaporating overnight.

All of which might suggest that I am anti-shares which of course I am not, quite the reverse though I do believe that property, for those fortunate enough to be able to invest in it in addition to their own home, is very attractive long term, principally as I say due to the gearing factor. But if you are going into shares to make money and want to do well, by which I mean much better than the modest market return, you have to find a strategy that is different to simply buying the market. And in doing so, too many small investors will fail.

Value is one such strategy, though I am not claiming it is the only one. I do think though that it is the one that is the most likely to succeed given the common sense basis of its philosophy which minimises the risks and critically, minimises that risk commensurate with the prospect of a making good rewards.