how to invest long term (updated to jan 2011)

March 2011 Investment Presentation 1/18

How To Invest For The Long Term


Within this presentation we will explain why we believe clients should invest in asset backed investments over the long term.

• We will show why we believe asset backed investments should outperform cash and inflation over the longer term.

• We will explain why some asset classes tend to outperform others.

• We will explain why we believe it is essential to diversify your investments.

• We will explain why risk and return are related and why we believe it is imperative to keep within your comfort zone.

• We will show that your “risk” reduces over time.

• We will show why we prefer passive funds.


PreambleThroughout these notes we have tried wherever possible to use 20 years of data, starting in January 1991 and finishing in January 2011.

In January 1991:

• Inflation was standing at 8.95%

• Bank base rate was at 13.88%

• The FTSE 100 was at 2,170

In January 2011:

• Inflation is at 5.09%

• Bank base rate is at 0.5%

• The FTSE 100 is at 5,863.

Back in 1991 if you used 10 year GILTS to generate £10,000 of income you would need (ignoring costs) £94,429.

To achieve the same income using 10 year GILT yields in January 2011 you would need £269,542, which is an annualised rate of return of 5.38% pa over the 20 year period. During the same period the average annual yield has been 7.2%. Had the FTSE 100 grown by the same sum it would now be at around 6,200 however the FTSE yield has typically been around 2.5% pa.

(Bank of England, FTSE and Wren Research statistics).


Why Invest in Assets Rather Than Cash?Over the longer term assets tend to perform better than cash or inflation:

Asset Growth January 1991 to January 2011

0%

100%

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600%

700%

800%

900%

Year

Tota

l Gro

wth

FTSE 100

International Equities

Emerging Markets

Property

Global Bonds

Cash

RPI


Are Some Asset Classes More Volatile (Risky) Than Others?

So Emerging Markets has an average return of 12.7% but in any one year this varies between

-24.2% and + 49.7%. Cash averages at 5.4% but in any one year this varies between 2.9% and 7.9%.

Standard Deviation Chart January 1991 - January 2011

0%

2%

4%

6%

8%

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14%

0% 5% 10% 15% 20% 25% 30% 35% 40%

Annualised Standard Deviation

An

nu

alis

ed

Re

turn

FTSE 100

UK Small


Emerging Markets

Property

Global Bonds

Cash


What About a Combination of Asset Classes?

Empirical evidence has shown that if you combine asset classes not only do you get a much less volatile investment return but you also get a better overall return on your savings. By choosing uncorrelated assets you can achieve reasonable returns in most markets as when some assets are going down, others normally rise.

A correlation of 1.0 indicates a perfect association, a correlation of 0 indicates no relation & a correlation of -1.0 is a perfect disassociation (ie one goes up when the other goes down).

02/1991 to 01/2011

Data Series FTSE 100 UK Value UK Small International Equities Emerging Markets Property Global Bonds

FTSE 100 1.00 - - - - - -

UK Value 0.86 1.00 - - - - -

UK Small 0.83 0.87 1.00 - - - -

International Equities 0.92 0.76 0.82 1.00 - - -

Property 0.60 0.57 0.81 0.66 1.00 - -

Emerging Markets 0.66 0.84 0.78 0.63 0.67 1.00 -

Global Bonds 0.31 0.15 0.10 0.27 0.17 0.22 1.00


Different Asset Classes For Different PeopleAt Swallow Financial Planning we categorise clients into one of 7 risk categories. These are based on your FinaMetrica score (1 to 100). If you want to know how we do this, please refer to our Risk Profile notes.

So the most cautious investor (i.e. with a FinaMetrica score of less than 20) is the wary one. On the other hand, the high risk investor (with a score of 90 +) is “Gung Ho”. holding the most volatile assets.

Investment option

Investor Type

FIXED/ CASH PROPERTY EQUITIES TOTAL

UK Intl UK Intl UK International

Core Value Small Main Markets

Emerging Markets

1 Wary 90.00% 10.00% - 100.00%

2 Cautious 60.00% 15.00% 10.00% 5.00% 10.00% - 100.00%

3 Prudent 30.00% 20.00% 15.00% 5.00% 15.00% 5.00% 10.00% 100.00%

4 Balanced 15.00% 10.00% 15.00% 10.00% 15.00% 5.00% 5.00% 20.00% 5.00% 100.00%

5 Adventurous 5.00% 5.00% 15.00% 5.00% 20.00% 10.00% 5.00% 27.50% 7.50% 100.00%

6 Speculative - - 10.00% 5.00% 23.00% 10.00% 10.00% 27.00% 15.00% 100.00%

7 High Risk - 10.00% 20.00% 20.00% 30.00% 20.00% 100.00%


Combining Assets Creates Better Returns

The High Risk portfolio contains the other asset classes but has beaten all but emerging markets whilst generating far less volatile returns (total return over 20 yrs 704%)

High Risk Portfolio v Asset Class January 1991 to January 2011

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1000%

1200%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

To

tal G

row

th

High Risk

FTSE 100

UK Value

UK Small


Emerging Markets


Combining Assets Creates Better Returns

Whilst FTSE 100, Property and UK Value have beaten the portfolio, the figures are very close and the volatility of the Prudent portfolio is a fraction of the others. (total return over 20 yrs 425%)

Prudent Portfolio v Asset Class January 1991 to January 2011

0%

100%

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800%

900%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

To

tal

Gro

wth

Prudent

Global Bonds

Property

FTSE 100

UK Value



Different Asset Classes Reduce Risk

Risk, in investment terms, is usually different from what a lay person considers as risk. Most lay people consider a risk as the risk of losing the physical value of their money. In investment terms is not the physical risk to the initial capital value, but rather it is the risk the investment will perform better or worse than expected. This is also called the standard deviation to the norm. If we look at the returns for the above asset classes over 20 years we have a table as follows:

As you can see, the use of a mixture of assets overall generates better returns at lower risk than does an equivalent asset class.

In About 70% of Time Periods

Data Series Annualised Return Standard Deviation Minimum Return Maximum Return

Emerging Markets 12.74% 37.00% ( 24.26%) 49.73%

High Risk 10.99% 23.17% ( 12.18%) 34.15%

UK Small 10.78% 27.73% ( 16.96%) 38.51%

UK Value 10.55% 27.92% ( 17.37%) 38.47%

FTSE 100 8.92% 18.79% ( 9.87%) 27.71%

Prudent 8.65% 9.75% ( 1.10%) 18.41%

International Equities 7.98% 17.61% ( 9.63%) 25.59%

Property 9.20% 26.98% ( 17.78%) 36.18%

Global Bonds 8.39% 5.38% 3.01% 13.78%


Wary has an average return of 5.7% with a best return of 11.9% and a worst return of 0.9% whereas Hi Risk has an average return of 13.5% however its best return was 47% and it’s worst return in a year was -33% If you don’t like short term risk, you will get a lower long term return.

Better Returns Means Higher Volatility

Highest and Lowest returns, Swallow Portfolios January 1991 to January 2011

( 35.00%)( 30.00%)( 25.00%)( 20.00%)( 15.00%)( 10.00%)( 5.00%)

- 5.00%

10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00% 45.00% 50.00%

Wary

Cautious

Prudent

Balanced

Adventurous

Speculative

High R

isk

Portfolio

Ret

urn

Highest

Lowest

Average

`


The Longer The Term The More Certain The Return

If you look at the best and worst returns from a selection of our recommended portfolios you see the following:

Best / Worst Returns

Annual: 02/1991 - 01/2011; Default Currency: GBP

Wary Prudent Adventurous High Risk

If you don’t need your money for 10+ years you can afford to take more risk knowing the return is more likely to be as expected.


This graph shows the average returns over 10 years ending in January each year. As you can see (withy the possible exception of emerging markets) the 10 year returns from all investments have been falling meaning we have to be far more aware of investment costs.

Long Term Returns Are Erratic And Are Falling

10 Year Returns ending January 2001 to January 2011

-4%

-2%

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18%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Year

To

tal

Gro

wth

RPI

Cash

Property

Global Bonds

UK Equities


Emerging Markets


Passive Funds Will Generate Better Returns

We explain our approach to investments in “Our Approach to Investment Management” notes. In brief, we believe investment returns in future will (on average) be relatively low. If an average passive fund has charges of 1% and an average managed fund has charges of 2.5% then managed funds cannot consistently match passive fund performance

£10,000 at a gross annual return of 5% over 20 years will grow to £26,500 with no charges, £21,911 in a passive fund or £16,386 in an active fund meaning the active fund has to grow by 6.5% to match the passive or a whacking 7.5% to beat the index.

Active Versus Passive Investment: The Effect of Charges

£10,000

£15,000

£20,000

£25,000

£30,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Years

Va

lue

No charges

Passive

Active


Sector Total Number of Funds

Funds producing above average returns for:

31st December 2007

3 consecutive years 5 consecutive years

Funds % Funds %

UK All Companies 346 38 10.98% 13 3.76%

UK Corporate Bond 121 15 12.40% 5 4.13%

North America 90 10 11.11% 1 1.11%

Europe (x UK ) 110 14 12.73% 3 2.73%

Pacific (x Japan ) 75 13 17.33% 2 2.67%

Japan 63 3 4.76% 0 -

(Source: Lipper Hindsight growth total return, default tax rate, in £ to 31/12/2007)

This schedule indicates the percentages of funds over 5 years which generate above average performances. With less than 5% of managed funds achieving a consistent return better than average, why take the risk?

Managed Funds Do Not Beat The Index


Do Not Time The Market!

The above shows the juxtaposition of each asset class performance in each of the last 10 years. Buying last year’s best performer or following pundits is a “mugs game”.

The Graham and Campbell study of 237 market timing newsletters showed that less than 25% of the “experts” predicted the right outcome once, let alone consistently. If we cannot get the asset timing right, we believe clients should remain invested in their optimum asset classes.

Rank Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011

1 7.19% 12.50% 58.88% 23.84% 58.16% 25.48% 22.17% 6.28% 63.79% 28.96%

2 4.88% 3.95% 55.16% 20.63% 36.13% 25.19% 6.29% 4.50% 59.10% 28.03%

3 2.68% ( 12.46%) 46.77% 19.42% 26.96% 19.68% 5.74% ( 18.66%) 57.25% 22.56%

4 ( 4.93%) ( 22.17%) 36.36% 17.76% 26.68% 11.29% ( 1.59%) ( 26.33%) 37.19% 22.11%

5 ( 8.30%) ( 28.08%) 27.68% 14.34% 24.36% 6.82% ( 1.94%) ( 31.23%) 30.40% 19.26%

6 ( 15.77%) ( 28.81%) 25.72% 5.74% 22.84% 4.81% ( 14.22%) ( 34.26%) 22.97% 16.78%

7 ( 15.97%) ( 29.44%) 7.10% 5.53% 4.72% 4.55% ( 15.13%) ( 39.16%) 6.52% 4.85%

8 ( 18.73%) ( 31.35%) 3.66% 4.64% 3.20% 4.23% ( 16.37%) ( 53.67%) 0.48% 0.48%

FTSE 100 UK Value UK Small


Emerging Markets Property

Global Bonds Cash


SummaryWithin this presentation we have tried to show in graphical form why we believe clients should have a diverse range of investments set up according to how much they are prepared to see the capital value of their investments fluctuate in the short term. We have also tried to explain why you should choose different sectors of the market which may well perform better than others over the longer term. Finally we have touched on our reasons for using passive rather than active fund managers.

So looking forward, what might the circumstances we find ourselves in now suggest that the next 20 years might bring? Well firstly unless we are to follow the Japanese into complete stagnation fixed interest rate investments can only go one way. If the underlying interest rates now are effectively 0%, then if inflation and economic growth ever return together yields will rise. If yields go up, the capital value of fixed interest securities (i.e. Government gilts and corporate bonds) will fall.

One could also argue that the long term outlook for commercial property is also somewhat subdued. If interest rates do rise then there will be some narrowing of the very wide risk margins we see now (typically yield to value are in the region 8% to 10% at present) but eventually the capital values will fall. Against this, however, there is the influence of new build costs to consider so there is always an element of inflation proofing over the longer term.

The value of an equity is the value of its dividends over the life of the share, so if the outlook for certain markets is uncertain (i.e. the gradual lowering of western standards of living in comparison with those in developing countries) then one needs to be circumspect over where one invests on a macro level at least.

But no one know what is going to happen! One thing we can be certain of is that if you want your investments to keep up with and hopefully beat inflation you will have to accept risk. This presentation explains how we try to give our clients the best returns for the minimum of risk in the years ahead.

Andrew Swallow March 2011.


Disclosure and Fund Information

The graphs and schedules within this presentation would not have been possible without access to the Dimensional Fund Advisors Ltd back tested database of funds. The funds we have used were somewhat restricted due to the desire to show 20 years performance (many indices are only 5 to 10 years old). The specific indices we have used are:

Citigroup World Government Bond Index 1-30+ Years (hedged)Dimensional Global Short-Dated Bond Index (gross of fees, hedged in )Dimensional Small Cap IndexDimensional Value IndexFTSE 100 IndexFTSE All-Share IndexMSCI Emerging Markets Index (gross div.)MSCI World ex UK Index (gross div.)S&P Global Property Index (gross div.)S&P Global REIT Index (gross div.)One-Month Treasury BillsRetail Price Index

In addition we have used Bank of England data concerning interest rates and related issues. Wherever possible we have included dividend income in the returns so as to compare all investments on a like for like basis.

•We have taken no account of charges (except in our comments re active fund managers) although clearly charges have a major effect on long term performance.•We have taken no account of taxation within our figures. At present in the UK capital gains tax is at a maximum of 28% and income tax is at a maximum of 62%. This makes a colossal difference to the end return on your investments.•Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

And finally, whilst we have tried our best to ensure that we have presented you with an accurate and well reasoned presentation any advice we give to clients must be client specific and not of a generalised nature. E.&.O.E.

how to invest long term (updated to jan 2011)

Economy & Finance