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The fear market

Last week, I started my look at some important current realities underpinning investment attitudes and action. These were founded on research carried out with US investors and advisers but I believe that there are some useful insights that we can draw on when considering the UK.

With this in mind, I thought it worthwhile reproducing some extracts from the article “Is it back to the fifties?” written by Deborah Brewster in the FT of March 25.The first two bullet points were reproduced last week but I thought it worthwhile to state them again this week so you have the whole picture without the need to cross-refer.

US stocks have fallen by more than 60 per cent in real terms since the market peaked in 2000. Anyone who started saving 40 years ago, when the post-war baby boom generation was just joining the workforce, has found that stocks have performed no better than 20-year government bonds since then, according to a forthcoming article by Robert Arnott for the Journal of Indexes. These people want to retire soon and the cult of the equity has let them down.

To find a period that does produce an outperformance requires a span reaching back a long way. The 2009 Credit Suisse Global Investment Returns Yearbook shows that, since 1900, US stocks have averaged an annual real return of 6 per cent compared with 2.1 per cent for bonds while in the UK, equities have beaten gilts with a return of 5.1 per cent against 1.4 per cent. The problem is that they can perform worse than bonds for periods longer than a human working lifetime.

This theory showed stocks would outperform in the long run. Stocks are riskier than asset classes such as government bonds (which have a state guarantee), corporate bonds (which have a superior claim on a company’s resources) or cash. So the argument was that those who invested in them would in the long run be paid for taking this risk by receiving a higher return.

That is now in question. “There’s no such thing as a risk that you get paid for taking. The whole point about risk is that you don’t know if you are going to be paid for it or not,” says Robert Jaeger at BNY Mellon Asset Management.

Last year, most equity mutual funds failed to beat their benchmark indices, even though their managers had the freedom to move into cash and to pick stocks. Burton Malkiel (a Princeton economics professor and author of the book A Random Walk Down Wall Street) points out that of the 14 funds that had beaten the market in the nine years to 2008, only one did so last year. Both efficient markets and behavioural economists say it is better just to match the index, with a tracking fund, and avoid the fees incurred in unsuccessful attempts to beat the market.

As tangible evidence of investor reaction to all of the above, consider the following.

In the biggest-ever exodus of money from professional management, Americans pulled a net $320bn (£218bn, euro 237bn) from mutual funds last year. They shifted into cash, ploughing a net $422bn into money market funds during the year. A net $212bn went into bank dep- osits – a figure that has risen further, to $370bn for the 12 months to mid-March.

“I have not opened a statement since October,” says one Los Angeles-based business owner, who adds that his holdings were worth more than $3m at the end of 2007 but declines to estimate their value now. “I know it is bad but what can I do about it? There is no point in depressing myself.”

George Gatch, chief executive of JP Morgan Funds, an arm of JP Morgan Chase, is working to re-engage with such investors. “We know how scared people are and we are trying to convince people to get back in, sit down and talk to their financial advisers,” he says.

The 50,000 advisers with whom JP Morgan works are reporting that “It is very hard to get their clients to consider the steps they should take, to do a formal review of their portfolio…There is a base of Americans that don’t want to look at their statements any more.”

“There is a tremendous amount of cash on the sidelines today. Retail investors have close to $13,000bn sitting in money market funds and bank deposits. A year ago, there was $7,000bn. That is billions that is just waiting to come back again.

“The demographics and people’s objectives have not changed because of the market,” says Bob Reynolds, chief executive of Putnam Investments. But, like others, he sees a shift to more conservative investing.

Jim McCaughan, chief executive of Principal Global Investors says: “Fear tends to lead people to want to talk to someone. They will go to the advisers and brokers, that is what has happened in past bear markets.”

There will be UK familiarity with many of the points stated above and, in particular, disin-vestment, the flight to cash and not facing up to the signi-ficant change in asset values.

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