7th January 2011

Schroders: Buy high and sell low?

Kevin Murphy, Specialist Value UK Equity Fund Manager

January 2011

Recent sales data shows heavy bond inflows despite all-time high valuations – leaving us wondering what happened to the basic investment concept of buying low and selling high?

The current situation mirrors that of 2000, when equities saw a huge increase in sales just as valuations went through the roof. Interestingly, bond sales have recently surpassed equity sales levels seen at the peak of the TMT bubble.

Sadly, many investors find it hard to imagine things can change and are strongly influenced by recent history, both bad and good. It’s therefore unsurprising that current strong bond sales come after a very positive decade for bond returns.

By contrast, equities have significant ability to grow dividends and a strong long-term track record of doing so.  In fact, in the last few years equities are seen as being as unpopular as they have been for 30 years, with US mutual funds suffering their first net redemptions (between 2007 and 2009) since 1979-81 (Saut & James, 2010).

Bonds are currently in the ascendancy but we would make the following points in support of equities from an income perspective:

• While equities will not provide the reliance of a fixed return at a specified date in the future, there are strategies that can help ensure your investment works for you over the medium term. The best way to achieve this is to avoid overpaying for stocks and to focus on a strong balance sheet.
• Additionally, while bonds can offer  a fixed return, this has the potential to be eaten away by inflation, so the real value of what you get back can be significantly reduced. Equities have a significantly greater capacity to avoid this reduction in value.

From an income perspective, most investors want the stability of payments, which bond coupons can provide. However, today many bond coupons are low by historic standards and there is no scope to grow those coupons, which are fixed for the length of your investment.

By contrast, equities have significant ability to grow dividends and a strong long-term track record of doing so (at about 5% p.a.). For investors who want an income stream that grows over the long term and has the ability to offset the impact of inflation, dividends represent an attractive option.

Additionally, after having gone through a nasty economic recession that saw many companies being forced to cut their dividends for the first time in decades, there is the potential for these companies to experience a significant rebound in dividend payments over the next few years.

Many investors are unsettled by the thought of using a “risky” asset class such as equities to fulfil an income requirement, where they want to see as little volatility as possible.

However, though it’s impossible to rule out further dividend cuts and stockmarket volatility, history suggests that in the long term these events are the exception rather than the rule.

For investors who want to preserve and grow the value of their investment while seeing long- term growth in their income, equities can represent a compelling place to invest.

1.    Saut, J. & James, R., Mr Market, advisoranalyst.com, September 2010

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