Investors in corporate finance are in denial

Feb. 13, 2013 - PRLog -- Historic lows for interest rates and bond yields mean low prospective returns on all assets within corporate finance. The London Business School authors of the 2013 Credit Suisse Global Investment Returns Yearbook, Elroy Dimson, Paul Marsh and Mike Staunton, claim that Savers and investors need to be more realistic about the new, low-return world.

This years 2013 Yearbook now includes three new countries, Austria, China, and Russia. It covers the five main asset classes, with a dataset that spans 113 years from 1900 to the present day.

The inclusion of Russia and China, where investors lost everything in 1917 and 1949 respectively, allows the authors to explore the impact of survivorship bias, and to estimate the long-run, historical, worldwide equity risk premium on a survivorship-free basis. In all, The Yearbook comprises feature articles, together with profiles of 22 national and three regional markets.

Professor Paul Marsh said: “Although we have been living with low rates for several years, many investors still seem in denial. Return projections by asset managers, retail savings product providers, pension funds, and even governments are often still too high. Such optimism is dangerous, because it misleads, and it also masks the need for remedial action.”

The low-return world within corporate finance:

The first feature article in the 2013 Yearbook examines the new investment landscape that we face following the financial crisis. It shows that:
•    Future bond returns are likely to be low, as indicated by current yields
•    Extrapolating the high bond returns of the last 30 years would be fantasy
•    Future returns on cash are likely to be even lower, at least for a generation
•    When real interest rates are low, real equity returns also tend to be low
•    The annualised future equity risk premium is also likely to be lower than over the second half of the 20th century
•    Many investors are still expecting, and even banking on, unrealistically high returns

Mean-reversion:

Professor Elroy Dimson explains: “Much of the evidence for mean-reversion is based on optical illusions based on hindsight. Investors – who sadly do not have the benefit of hindsight – will find that market timing, using mean reversion rules, is more likely to hurt performance than enhance it.”
It has been suggested that that equity and bond returns revert to the mean. The second article in the year book addresses this claim and observes; if this were true- it would reduce risk, and provide market timing signals to help boost investors’ returns.

The authors’ research reveals that:
•    Higher returns have tended to follow periods when prices were low relative to fundamentals, and vice versa, when viewed over history
•    But this relationship is weak, “noisy”, and fallible, giving many false signals
•    Some markets take a long time to revert and some never do
•    More fundamentally, when judgments about whether prices are “low” or “high” are based not on the entire history of returns, but solely on what investors would have known at the time, mean reversion loses its power

The yearbook is accompanied with the 2013 sourcebook, which documents the global long-term and shorter-term rewards for equity and bond investing. The sourcebook examines risk over the long run investment statistics for 22 countries and three regions, including the world index; and the historical extremes of investment performance.

Since the beginning of 2000 equities have mostly disappointed, notwithstanding their recent rally. However, over the long run, the Sourcebook shows that they have beaten inflation, bonds and cash in every country with a continuous 113-year history.

The Sourcebook also reports the following:
•    a size premium (the amount by which smaller companies outperform larger ones) that has been positive over long intervals and many countries
•    a value premium (the amount by which value stocks outperform growth stocks) that has been larger than the size premium
•    an income premium (the amount by which high-yielding stocks outperform low-yielding stocks) that has been larger than the value premium
•    a momentum premium (the amount by which past winners outperform past losers) that is largest of all

For more information on investment in corporate finance, please visit http://www.london.edu/newsandevents/news/