Tuesday, 1 March 2011

Global Investment Returns Yearbook 2011 from Credit Suisse

The 2011 edition of the Credit Suisse Global Investment Returns Yearbook is out ( free download here). It is again full of fascinating material that gives a long term (111 years of data from 1900 to 2010) perspective on investment returns of stocks and bonds across 19 countries, including Canada, which again looks rather good compared to just about anywhere else. It also has three excellent topical articles, two by principal authors / data compilers Elroy Dimson, Paul Marsh and Mike Staunton, and one by Credit Suisse analysts David Holland and Bryant Matthews. These are my highlights:

Stock-Bond Drawdown Extremes, Correlations and Inflation Impact
  • Equities outperform bonds over the long run ... "Yet that superiority [of equities] has been dented by the striking performance of bonds over intervals that exceed the investment horizon of most individuals and institutions." e.g. 1980 to 2010 (31 years)
  • "Historically, bond market drawdowns have been larger and/or longer than for equities. ... UK government bonds were underwater, in real terms, for 47 years until December 1993. While bonds appeared less risky in nominal terms, it is clear that their real value can be destroyed by inflation" [Drawdown = the difference between the portfolio’s value on a particular date and its high-water mark] Look at figure 2 (USA) or 3 (UK) for visual proof of how unsafe bonds can be.
  • The drawdown of a portfolio 50% stock 50% bond portfolio has been much less pronounced and much briefer - see figure 4 - i.e. a balanced portfolio really reduces risk.
  • Correlations between stocks and bonds have been negative for the last few years. That has been great for diversification in regularly rebalanced portfolios but the correlation is likely to rise so the risk reduction effect won't be as strong.
  • The past decade has been brutal for equities. Here is what they write about the US, which is more or less the case for every country: "After the tech-bubble burst in March 2000, equity prices also collapsed and, by October 2002, the real equity index was down in nominal terms by 48%, and in real terms by 52%. While the nominal recovery took only 47 months, in real terms the market remains underwater to this day."
  • "It is sheer fantasy to expect bond performance to match the period since 1982. Yet expecting bond returns to be lower than in the golden era is not the same as asserting they will enter a protracted period of negative performance." Bond returns might simply remain low but positive.
  • High inflation is to be feared. All sorts of bad things happen - bond prices have their worst drawdowns. Stocks experience big losses too. And the correlation between stocks and bonds increases, lessening the risk reduction achievable from diversification.
  • Real returns on bonds are higher [not lower, as one might think] in high inflation countries but they find that only reflects greater risk in the form of volatility and uncertainty
Dividends and Dividend Yield Investing
  • "... long-term returns are heavily influenced by reinvested dividends ... the total return from US equities, including reinvested dividends, grows cumulatively ever larger than the capital appreciation ... the longer the investment horizon, the more important is dividend income. For the seriously long-term investor, the value of a portfolio corresponds closely to the present value of dividends"
  • "... historically, investment strategies tilted towards higher-yielding stocks have generally proved profitable ..."
  • Stocks with high dividend yields provide higher returns, even after adjustment for risk: "... an equity investment strategy tilted towards higher-yielding markets would have paid off handsomely"
  • "... our research indicates that portfolios of higher-yielding stocks (and countries) have actually proved less risky than an equivalent investment in lower-yielding growth stocks". They lay out the long term evidence for 21 countries in the chart below which plots the risk-adjusted return metric known as the Sharpe ratio compared to high- vs low-yielding stocks. It sure looks like investing in high dividend stocks pays off. It also looks like investing in no-dividend stocks will greatly under-perform.
  • Similarly, investing in countries with high dividend yields e.g. through a market index, has paid off handsomely. "... the high-yielding countries outperformed the low-yielding countries by an appreciable margin. The results are not therefore period-specific. Nor are they attributable to risk."
  • However! "... there can be extended periods when the yield premium goes into reverse and low-yielders outperform ... there have been extended periods when even the rolling five-year premium has remained negative. These include the early 1980s, much of the 1990s, and the present time"
Expected Future Equity Returns
Holland and Matthews use a model to assess what current market expectations are for future equity returns of industrial firms based on analyst forecasts of future cash flows.
  • As of mid-January 2011, the required rate of return on industrials in the USA was at 5.1%, which is less than the historical median of 5.8%, implying a market where investors are willing to take on risk. The current figure is just at the dividing line they label overheated. But the premium of equity to Treasuries, the equity risk premium (ERP), is still attractive, so stocks looks good in that sense. "We would caution bullish investors that the risk premium will only stay high so long as Treasury yields remain low. A robust global recovery would stoke inflation and long-term Treasury yields."
  • "We estimate the ERP for key regions in Figure 6, and see that the ERP for developed markets is far more attractive than the ERP for developing markets. This prompts the question of whether equity investors will be compensated for the extra risk they are taking in developing markets."
  • Canada has been one of the best countries in the world to invest in over the past 111 years. "Canadian equities have performed well over the long run,
    with a real return of 5.9% per year. The real return on bonds has been 2.1% per year." On equities returns, that ranks it behind only Australia (7.4%), South Africa (7.3%), Sweden (6.3%) and the USA (6.3%) amongst the 19 countries listed. Resource-rich countries have done well.
  • It seems to continue to be a good place to invest - falling in the middle of the over/under heated charts (see Figure 5 on page 29)
  • Canada's stock market was the world's 4th largest as of the end of 2010. I wonder if Bloomberg will ever notice and start displaying the TSX on its TV channel streamers.

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