Why the returns
from your investing
may be less than
you think
Pete Comley
Disclaimer
This talk is for educational purposes only and
does not constitute professional advice.
Q. How much do you hope to make
on your investments in 2013?
0-5%
6-10%
11-20%
20%+
“[Our aim is] to help
you return 12–15%
per year over the
long term.”
“Historically, [stocks] yield an
investment return of about 10%.”
Annual Real Returns on Equities
and Cash (after inflation)
1899-2011
4.9%
0.9%
Equities
Source: Barclays Equity Gilt Study, 2012
Cash
Returns are less over the last
decade
4.9%
1.2%
0.9%
0.2%
2001-2011
1899-2011
Equities
Source: Barclays Equity Gilt Study, 2012
Cash
Is the return calculation really
that simple?
These are theoretical returns.
What about….
Skill
Returns
Costs
• Stocks/funds you pick
• Your strategies
• Timing of your trades
• Published indices
• Dividends
• Survivorship bias
•
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•
•
•
•
•
•
•
•
Annual fund charges
Commissions to intermediaries
Bid/offer spread
Trading commissions
‘Price impact’
Broker account fees
IFA fees
Stamp Duty
Tax on dividends
Capital gains tax
How do best measure skill?
Results of Shares4Schools
Competition 2011
8.1%
Average gain/loss of a school
FTSE All Share Index gain/loss
-13.1%
Just 6 of the 72 schools beat the FTSE
% Net Gain/Loss of UK
StockChallenge Investors vs FTSE
2011 -30.5%
2010
26.5%
2009
2008
2007
51.5%
-28.5%
-16.3%
2006
-13.5%
2005
-13.9%
2004
Average
-6.5%
-3.9%
Source: http://stockchallenge.co.uk/
Monkeywithapin =
the random stock picking entry in the
UK Stock Challenge competition
2011 – Monkey in top 10%
2012 – Monkey in top 10%
Ola the Chimp
Competition over a month
with 5 pro traders.
Ola’s gains X4 best other
pro!
Wall Street Journal Competition
• 147 monthly competitions between 1990-2002
• The competition:
– Top 4 Wall Street pros each picked a stock
vs
– Editorial staff threw darts into the paper
• Results assessed after 6 months
Re-analysis of Wall Street Journal
Random Darts vs Pro Investors
Competition
He invested $1 on each of the four
dartboard tips each month and just held
those shares until the end in August 2002.
He invested $1 on each of the four pros tips
each month and at the end of each 6
months competition, he sold them all and
invested the proceeds and another $4 into
the pros next set of 6 month tips.
As a control, he invested $4 a month into an
index tracking fund of the US market (the
Vanguard Index Trust 500).
Source: E.Porter , Journal of Applied Finance (2004)
$1,368
$1,091
$957
Amounts Lost Per Year by the
Average Taiwanese Investor
Trading losses
-1.3%
Commission charges
-1.2%
Stamp duty tax
TOTAL
-1.3%
-3.8%
Source: Barber, Lee, Li and Odean, University California Berkeley, Working Paper (2005)
Why skill is low:
x Poor stock picking
x Bad timing
Investors in funds worse
• DALBAR analyses ALL US mutual funds
• Returns after inflation over last 20 years: -5%pa
• -5% a combination of:
– Poor fund selection/timing
– Fees
£35
8000
£30
7000
£25
6000
£20
5000
£15
4000
£10
£5
3000
£0
2000
Source: IMA
FTSE (December 1st)
Net fund retail sales (£bn)
Fund Sales are Correlated to the FTSE
Factors reducing investors
returns
Skill/alpha of the investor
Skill/alpha of a fund manager
Investors
in shares
directly
Investors
in funds
directly
–1.3%
–2.2%
n/a
+0.2%
What is the FTSE?
Change in the top 20 FTSE shares from 2001-2011
Vodafone Group
BP Amoco
GlaxoSmithKline
HSBC Holdings
AstraZeneca
Shell Transport & Trading
Royal Bank of Scotland
Lloyds TSB Group
British Telecommunications
Barclays
Diageo
Cable & Wireless
CGNU
Prudential
British Sky Broadcasting
Marconi
Tesco
Abbey National
Unilever plc
Reuters Group
AVERAGE (top 20)
FTSE 100
-29%
-10%
-33%
-30%
-12%
11%
-97%
-90%
-33%
-87%
60%
-87%
-62%
-37%
-34%
-100%
57%
-54%
244%
-35%
-23%
-3%
Source: Comley (2012)
Disappearing funds
• In the UK, the fund industry closes 10% of
failing funds each year
• Beware: Fund stats only show successful ones!
• Estimated effect = -1% pa
Source: Rohleder, Scholz, Wilkens, Review of Finance (2011)
Effects of survivorship bias on indices
• I can’t find any definitive work on it
(idea for a dissertation??)
• However not using complete datasets has a
massive impact on financial models
Source: Frank Hassler – http://engineering-returns.com
Factors reducing investors
returns
Skill/alpha of the investor
Skill/alpha of a fund manager
Index error due to survivorship bias
Investors
in shares
directly
Investors
in funds
directly
–1.3%
–2.2%
n/a
+0.2%
–1.0%
–1.0%
Q. What is the average size of your
trades?
£250 (or less)
£500
£1000
£++more
Costs of trading shares
Commissions
£250 10%
£500 5%
£1000 2.5%
Stamp duty
Spread
TOTAL
0.5%
0.5%
0.5%
0.7%
0.7%
0.7%
11.2%
6.2%
3.7%
+ account fees
+ tax
Fund Charges
• Annual fees (TER): 1.7%
– Can be less on passive funds
– Can be a lot more!
• Bid/offer spread: 5%
– Can often be much less*
* For my calculations, I have assumed an average 2.5% spread
amortised over 5 years i.e. 0.5% pa.
• Distribution levy: small
The Hidden Costs
• TER (Total Expense Ratio) excludes:
– Trading commissions
– Stamp duty
– Bid/offer spreads
– Price impact
• Hidden costs are very dependent on
Portfolio Turnover Rate (PTR).
• Assuming 60% PTR, hidden costs = 0.6%
Investors
in shares
directly
Investors
in funds
directly
–1.3%
–2.2%
n/a
+0.2%
Index error due to survivorship bias
–1.0%
–1.0%
Trading commissions
–2.5%
–0.1%
Stamp duty
–0.5%
–0.3%
Bid/offer spreads
–0.7%
–0.1%
Price impact
n/a
–0.1%
Initial charge/distribution levy
n/a
–0.5%
TER
n/a
–1.7%
–6.0%
–5.8%
Factors reducing investors
returns
Skill/alpha of the investor
Skill/alpha of a fund manager
TOTAL
-0.6%
True Returns on Equities vs
“Cash” over the last 20 years
4.8%
2.90%
-1.2%
Theoretical equity return
1991-2011
Actual equity return
Cash -Building society returns
Example: Endowment Policy
•
•
•
•
25 year policy from 1988-2013
Projected returns: >£48k
Paid in: £17,250
Value now: £27,500 (4.2% growth)
– But inflation averaged 3.5%
– Stock market return of 9.2%
• Where is the missing 5%???
Cash would have better than share
investing over the last 20 years
£100,000
£80,000
Real equity returns
£60,000
Janet (Cash ISA)
John (Share ISA)
£40,000
Total contributions
£20,000
£0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
What might be future equity returns?
• Deutsche Bank predicting 0.6% above inflation
(in the US) for the next decade
• Barclays Mortgage Dept now assume returns
from Stock ISA investments over next 25 years
will be:
– Just the cash you pay in (not even inflation added)
What might be future cash returns?
• “Financial repression” will ensure:
interest rates remain low (for as long as possible)
However don’t expect cash to outperform in the future
£17,500
£16,829
£15,000
£14,875
£13,552
£12,500
£10,000
Inflation @ 5%
John (Monkey Share ISA)
£7,500
Janet (Cash ISA)
£5,000
£2,500
£0
2012
2014
2016
2018
2020
2022
Three tips to cut your costs
1. Trade less
2.Trade less
3.Trade less
Some other tips to cut your costs
•
•
•
•
Pay no more than £10-£12 commissions
Trade as large a size as possible
Check bid/offer spread before buying
Read small print charges and avoid any that
charge annual fees, inactivity fees, etc
• Pick funds that have low annual charges and
low initial charges/provide rebates
• Use funds for international exposure
What’s the best strategy?
“Buy and hold will be poor option
[over the next decade]”
Turtle Traders
• Richard Dennis bet William Eckhardt
that anyone could be trained in 2
weeks to be a successful trader
• 2 of the 14 went on to earn $175m
• The secret: follow a system
The secret to successful investing
Recognise that you need rules
Determine some good rules
Follow those rules
My Strategy
My view on the FTSE
FTSE
50
Cyclically Adjusted PE ratio
(S&P index)
45
40
35
30
25
20
15
10
5
0
1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011
My stock selection strategy
• Low cost trackers
• Stocks selected by a monkey
Finally, the missing 6% equates to:
£170bn a year
UK Health and
Education
budget
£3000 for every
UK citizen
Thank you
You can download the book for FREE in all eBook
formats from monkeywithapin.com