Missing link – If you do not happen to be clairvoyant, try looking back at history instead


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

In articles such as In the picture, Gross misconduct and Greatly dubious premise III, we have discussed the relationship, or lack thereof, between GDP growth and equity returns. Yet it now turns out there could indeed be a link after all – just not the one you might expect and certainly not one many investors will be inclined to heed. 

We are grateful – sort of – to a colleague in the Schroder Maximiser team, who flagged up the discrepancy by drawing our attention to the 2014 version of the Credit Suisse Global Investment Returns Yearbook. This contains an article that analyses the relationship between GDP growth and equity returns more deeply by crunching data from 85 countries for the period 1972 to 2013.

To evaluate portfolio performance based on economic growth, the article’s authors – Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School – created five hypothetical and annually rebalanced ‘tracker’ portfolios comprising equities from the lowest-growing, lower-growing, middling-growth, higher-growing and highest-growing economies.

They then looked at the portfolios in two ways, the first of which was as if they were clairvoyants who could always correctly predict the future GDP growth of all the countries under examination. They then allocated them into the five portfolios based on these future growth rates. The second way, more prosaically, involved looking at history and allocating countries into the five portfolios based on their historic growth rates instead.

So which of these 10 portfolios – five clairvoyant, five historical – produced the best returns? Perhaps unsurprisingly, being able to tell the future with perfect accuracy is no small advantage when it comes to investing and being able to spot the highest-growing 20% of economies in advance would have netted an impressive 30% annual return for those able to do so.

The problem being, of course, that nobody in the real world can tell the future with perfect accuracy, which makes it doubly interesting that coming in second place – and ahead of being able to spot the second ‘higher-growing’ band of countries in advance – was picking out the economies that had delivered the lowest growth on a historical basis.

This approach would have achieved some 25% growth per year – not as good as the flawless clairvoyants’ 30% but, then again, if you are genuinely able to tell the future, you probably deserve your 5% premium, rather than having to pitch your tent in a fairground or on a pier. On the other hand, the method that generated the still formidable 25% annually is somewhat more achievable because all people need to do is to look in a book to see what has already happened.

Focusing on what you can absolutely know for sure from the past rather than trying – let’s be honest – to guess what will happen in the future just makes for an easier – and wealthier – life, it would appear. Yet few people seem willing to do this – preferring, regardless of the lessons of history, to focus on the more seductive, if less substantial, charms of whatever is currently thought fashionable.

Clearly this kind of thinking is anathema to us here on The Value Perspective although we do console ourselves with the knowledge that, the more short-term the broader market becomes, the greater the potential benefits of a longer-term investment strategy, such as value – one of the lessons of which is that a business that has done badly in the past could well improve if only one has the patience and strength of mind to let it.


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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