There are opportunities for long-term investors to outperform when the market takes a short-term view on risk, says ABN AMRO / London Business School study.
For long-term investors, protecting portfolios against short-term losses is counterproductive and downside protection hurts performance disproportionately, according to the authors of the ABN AMRO Global Investment Returns Yearbook 2007. ABN AMRO is a leading Dutch bank.
Returns 1900-2006
Figure 5 shows that out of the 17 GIRY countries, the best performing equity markets over the very long term are Sweden and Australia, with annualised percentage real returns since 1900 of 7.9% and 7.8%, respectively, compared to a world average of 5.8%. Ireland had a real annual return of 5%
Downside Protection Erodes Returns
The Yearbook – published annually in partnership with Professors Dimson, Marsh, and Staunton of London Business School – is the most comprehensive and authoritative work of its kind. It examines total returns since 1900 for stocks, bonds, cash and foreign exchange in 17 major markets, covering North America, Asia, Europe and Africa.
This year’s study takes a close look at volatility and investment strategy. The authors answer some very practical questions: Does it make sense to protect a portfolio against downside risk? And what, historically, would have happened to portfolios if investors had always protected their downside?
They conclude: "Downside protection erodes returns, and by more than risk is reduced. The best way to control risk is to diversify across securities, across assets, and across markets."
Rolf Elgeti, ABN AMRO’s Head of Equity Strategy, highlights stock market distortions because of the different time horizons of investors and their fund managers. He says: "What investors typically ought to do is to take risks that other investors do not want, or are not allowed to take – because these risks tend to offer a higher risk premium. Things that seem difficult to do are often precisely the ones that are worth doing."
It may have seemed difficult so stay in stocks after the tech bubble burst, for example, but four years of exceptional equity returns have largely eliminated losses from the savage, start-of-century bear market. This is remarkable, since at the trough in March 2003, US stocks had fallen 45%, UK equity prices had halved, and German stocks had fallen by two-thirds.
The authors analyse the performance of global markets over 2006 and over the first seven years of the decade, highlighting what happened, and why. They provide a comprehensive update on the long-term record of stocks, bonds, bills, inflation, and risk premia around the world.
The book provides a detailed record of performance from the main asset classes, cumulatively over many decades. For example, every £1 invested in the UK equity market at the start of 1955 would, with dividends reinvested, have grown to £776 by the end of 2006, a return of 13.6% per annum.
For every country there is a statistical summary of long-term risk and return; tables of performance over periods of any length from 10 to 107 years; graphs of annual and cumulative returns, both nominal and real; measures of the dispersion of equity and bond returns over any investment horizon; and cumulative index values from 1900.
Report Synopsis
