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Historical investment analysis

Modest inflation rises, based on historical precedent, should not adversely affect the real return on equity investing, says annual Credit Suisse Global Investment Return Yearbook 2017 co-authored by Elroy Dimson of Cambridge Judge.

With inflation at a multi-year high in the US and rising in Britain due to Brexit, equity investors who have enjoyed a healthy historical premium over cash “should not fear modest rises in inflation,” according to long-term lessons outlined in a report on investment returns co-authored by Elroy Dimson of Cambridge Judge Business School.

The Credit Suisse Global Investment Returns Yearbook 2017, issued today (21 February), looks at returns on equities, bonds, bills and other assets for the 117-year period from 1900 through last year.

Professor Elroy Dimson

Equities outperformed cash by 4.2 per cent on average per year, and are expected to enjoy a somewhat lower premium of 3 per cent to 3½ per cent in the long term given today’s low interest rates, the report said. But based on historical precedent, a modest inflation rise is not expected to adversely impact the real return on equities.

Consumer prices in the US rose in January at the fastest pace in nearly five years, standing at 2.5 per cent higher than in January 2016, while annual UK consumer prices rose 1.8 per cent in January owing partly to a falling pound following last year’s Brexit referendum.

The 260-page yearbook, published by the Credit Suisse Research Institute, in collaboration with London Business School, looks at long-term return data and risk premium estimates for 23 national stock and bond markets. Those countries include the US, UK, France, Germany, China, Japan and South Africa – together representing 98 per cent of the global equity market in 1900 and 91 per cent of the global investable universe at the start of 2017.

The report is authored by Professor Elroy Dimson, Chairman of the Newton Centre for Endowment Asset Management at Cambridge Judge Business School and Emeritus Professor of Finance at London Business School; Paul Marsh, Emeritus Professor of Finance at London Business School; and Mike Staunton, Director of the London Share Price Database at London Business School.

One chapter of the Yearbook deals with factor, or smart-beta investing, which focuses on long-run factor premiums. The report looks at incremental returns to investing in stocks that are small, value-oriented, high-yielding, have favourable momentum, or are low-volatility.

“Smart-beta investing raises the question of whether a pattern in past returns will persist into the future,” said Elroy Dimson. “While the long-term numbers are reassuring, the investor should not be complacent. After publication and after the investment opportunity has been popularised, the rewards to smart-beta strategies are considerably reduced.”

Other key chapters deal with returns of various asset classes based on a long-term returns database assembled by the authors; and on risk and risk premiums, particularly the additional return investors require from investing in risky equities rather than risk-free cash or treasury bills.

“Disruptive technology continues to re-shape many industries, but this is not new and has been happening for more than 200 years,” said Paul Marsh. “However, investing in disruptors requires care. Historically, investors have if anything placed too high a value on new technology, overvaluing the new, and undervaluing the old.”

Discussing the equity premium, Mike Staunton said: “In today’s low interest rate environment, expected returns from investing in shares and all other assets are much lower than a decade ago. Inflation expectations have risen recently, but based on historical precedent, we do not expect modest rises in inflation to adversely impact the real return on shares.”