Scrutineer: High Beta, low Beta ? or just Beata retreat?

TWO arguments have come sharply into focus among equity investors. The first centres on the startling shift that has seen defensive sectors knocked off their perch this spring as cyclical shares have staged a marked rally. Sectors categorised as low Beta ? that is, those whose fortunes are less correlated with fluctuations in the business and economic cycle ? have fallen behind this spring. Low Beta sectors include tobaccos, pharmaceutical companies, utilities, drinks and food retailers.
Sectors described as high Beta ? those more closely correlated with the business cycle ? have roared back into fashion. Typically high Beta sectors include banks, electronic and electrical equipment, construction, housing, mining, cars and car parts.ADVERTISEMENT

Is this the start of a shift that could see cautious investors left behind as the year progresses ? or a brief flurry of premature optimism?

But there is a second, altogether more serious dilemma facing anyone saving for the long term. This challenges the long-standing rationale of equity investment. The belief to which equity investors have clung in previous bear markets is that, over the long term, equities outperform bonds and that, therefore, those starting up a nest-egg for retirement should favour equity funds over bond or fixed interest funds. This became known from the 1950s as “the cult of the equity”. But this fundamental view has come under increasing challenge ? and if this is dislodged, then the hopes of a generation will have proved unfounded and the future for equity investment is bleak indeed.

Rob Arnott, the head of Research Affiliates, finds that in the 40 years to the end of February, and again to the end of March, long dated US government bonds had slightly outperformed US equities. That is bad news indeed for a generation coming up for retirement whose financial advisers have sunk the bulk of their pension savings into equity funds.

The picture in the UK is equally dismal. For the past 40 years the message has been drummed into the investing public that equities are best. The emphasis on long-term performance also helped to ensure that the failures and inadequacies of fund managers would be eroded over time. All would be borne aloft. But will this continue to be true?

George Blakey, author of A Post War History of the London Stock Market, raises big doubts. Ten years ago, he points out, the FTSE 100 was around the 6,500 mark against a figure of just a little over 4,000 today. But far more striking is a comparison of prices then and now of the darlings of the technology, Media and Telecoms boom, many of them FTSE 100 constituents.

“Computer software and service companies Logica and Misys, have both lost over 80 per cent of their value, media giants Pearson and Daily Mail have more than halved, while in Telecoms Vodafone and BT shareholders have seen the value of their shares fall by 70 per cent and over 90 per cent respectively.

“It would take a brave fund manager”, says Blakey, “to bet that any of these stocks will recover to their 1999-2000 and 2007-8 peaks over the next ten years, and on the record of the past ten, most investors would agree that equities have shown themselves to be ‘mad, bad and dangerous to know’.”

Blakey notes that the market itself appears to be having doubts over historic value rationales. For example, the return of the original yield gap last September ? equity yields exceeding those on government stock, a historic buy signal in the past ? went largely unnoticed and unappreciated.

“In such a context”, he writes, “the sharp recovery since early March has been largely meaningless in the cause of returning equities to favour as indeed are attempts to call the bottom of the market in big index terms ? Arguably the traditional ‘long-term investor’ has no role to play in today’s dangerously volatile market conditions or perhaps at any time in the foreseeable future.”

Put another way, this bear market is more than just a cyclical “correction” but may have exposed an epochal “wrong call” by the pension fund industry that has condemned millions of households to a massive loss in their lifetime savings. If the long-term case for equities does not stack up, and our savings best kept in government stocks or a bank deposit account, it barely matters whether you’re equity portfolio is High Beta or Low Beta ? you should beat a retreat out of it.

However, there are some pieces of wreckage to which the fund management industry can cling. First, past performance is no guide to the future and it may well be that equities could outperform bonds in the future. And second, inflation may come to the rescue of equities by lifting the nominal prices of assets and destroying the value of government bond returns.

That is a bleak prospect for the UK, and risks the conversion of a heavily indebted Britain into a fully failed state. The rescue of equities may thus involve the biggest financial risk of all time.