GM82: The Surprising Success of the U.S. Economy ft. Elroy Dimson & Kiran Ganesh

America's recent economic performance has been a surprise, as it's managed to outperform many other markets over the last quarter century. We review the insights from the Global Investment Returns Yearbook, discussing how the US has thrived and what that means for future investment strategies. Our guests, Elroy Dimson and Kiran Ganesh, share their expertise on market trends, the importance of diversification, and the implications of recent economic shifts. We also explore the complexities of factors like equity risk premium and the evolving role of bonds in an investment portfolio. Join us as we explore these themes and consider what’s next for investors in a changing global landscape. You can read the Global Investment Returns Yearbook here.

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Episode TimeStamps:

02:19 - Introduction to Elroy Dimson and Kiran Ganesh

09:21 - What kind of feedback do they get from clients?

13:04 - Stocks for the long run?

17:41 - Is the US losing its grip on its economy?

24:08 - Are indicies...

Episode Transcript

(00:07):
We would not have expectedAmerica to continue to be world beating
compared to other markets. Wewere wrong on that. America has had

(00:31):
a marvelous quarter centurythis time around. Thelast few months
have become a bit more of apuzzle, but the first 25 years of
the new millennium have beenvery favorable for the United States.
And so, one of the thingswhich you might come back to later
on is what we think willhappen for the future.
Imagine spending an hour withthe world's greatest traders. Imagine
learning from theirexperiences, their successes and

(00:56):
their failures. Imagine nomore. Welcome to Top Traders Unplugged,
the place where you can learnfrom the best hedge fund managers
in the world so you can takeyour manager diligence or investment

(01:26):
career to the next level.Beforewe begin today's conversation,
remember to keep two things inmind. All the discussion we'll have
about investment performanceis about the past, and past performance
does not guarantee or eveninfer anything about future performance.
Also understand that there's asignificant risk of financial loss
with all investment strategiesand you need to request and understand
the specific risks from theinvestment manager about their products
before you make investmentdecisions. Here's your host, veteran
hedge fund manager Niels Kaastrup-Larsen.
Welcome and welcome back toanother conversation in our series
of episodes that focuses onmarkets and investing from a global

(01:52):
macro perspective. This is aseries that I not only find incredibly
interesting as well asintellectually challenging, but also
very important given where weare in the global economy and the

(02:16):
geopolitical cycle. Wewant todig deep into the minds of some of
the most prominent experts tohelp us better understand what this
new global macro-driven worldmay look like. We want to explore
their perspectives on a hostof game changing issues and hopefully
dig out nuances in their workthrough meaningful conversations.
Pleaseenjoy today's episodehosted by Alan Dunne.
Thanks for that introduction,Niels. Today I'm delighted to be

(03:08):
joined by Elroy Dimson andKiran Ganesh. Elroyis professor
of Finance and Director ofResearch at Cambridge Judge Business
School. He is a founder andChairman of the Centre for Endowment
Asset Management at Cambridge.He was formerly Chairman of the Strategy
Council for Norway's SovereignWealth Fund and his research focuses
on Long Horizon Investing withhis notable books including the Triumph
of the Optimists and he is oneof the authors of the Global Investment

(03:35):
Returns Yearbook which we'retalking about today. Andalso, I
have Kiran Ganesh who is aManaging Director and Head of Investment
Communications at UBS GlobalWealth Management. In his role he
leads a team responsible forwriting UBS's House View from a macro
perspective. And he regularlymeets with clients to advise on financial
markets and appears regularlyin the financial media. So, that's
a lot to get through. Two veryaccomplished guests. Great to have
you both with me today. Imightjust kick off by getting a
quick sense on yourbackgrounds. Quite different obviously,
but we do like to get a senseon our guests, how they got involved
in their respective fields. Somaybe. Elroy, I mean, obviously you've
spent a long time researchingfinancial markets and financial market
history and asset marketreturns. What got you interested
in that in the first place?
Well, if you take my journeyback to earlier stages of my career,

(04:05):
I was at London BusinessSchool. I did a degree at LBs, just

(04:27):
like Kiran did at an earlierstage for himself (so, perhaps we're

(04:47):
not quite so divergent). I'vespent a long time looking at indexes,

(05:07):
designing indexes and lookingat the performance of markets around
the world. Ithink,althoughI’d done earlier work, probably the
point I'd start is the designof the FTSE 100 index which I undertook
with Paul Marsh when we wereat London Business School. And what
followed on from that was acontinuing interest in creating indexes
and understanding what a goodindex would be and what a weaker
index would be. Atthe end ofthe 1990s, the organization with
which we were producing anumber of index numbers pointed out
that Millennium was coming up,and that it was soon going to be
New Year 2000, and we ought tohave something which celebrates that.
And instead of looking againat US and UK data, we gathered together
data for a number of countriesaround the world. We called it the
Millennium Book for the NewMillennium. Andit was the Millennium
Book also because we had 100years of data for each of 10 different
national markets. So, we had1,000 years of data. We launched
that. It segued, in the end,into other work and the continuing
yearbook which we produce inconjunction with UBS.

(05:28):
Very good, and Kiran,obviously you kind of started with
a similar academic backgroundbut have spent most of your career
in UBS. I mean, what got youinterested in the markets in the
first place?
Well, I think, when I was akid, I quite enjoyed playing fantasy

(06:05):
football and picking myplayers and seeing who would perform
well on the weekends. And Ithought that this would be a sort

(06:46):
of more grown-up version ofthat, perhaps, constructing portfolios
of stocks and seeing whatwould win. Ithinkwhen I was a bit
younger, I think I had aclearer belief that I could really
pick the winners and watchthem rise. So, I entered into investment
banking with bright eyes on arather inauspicious day. My first
day at UBS was the day thatLehman Brothers collapsed, or the
morning after Lehman Brotherscollapsed, I should say. So, back
in 2008 initially I was in anequity research role looking at stocks
in the media and telecom spaceand then later moved on to a broader
role which has really led tomy position today which is in UBS

(07:11):
Global Wealth Management.Andits quite an interesting seat
because I'm able to reallygather together and discuss macro
views with all of ourspecialists, whether economists,
or asset class specialists, orpeople covering single securities.
And then it's myresponsibility and my team's responsibility
to try and bring thosetogether into the overall house view,
which, particularly at thesevolatile times that we're in today,
is quite an interesting roleto be in. There’scertainly lots
of questions that we get fromclients, and then we're charged with
trying to find a good andconstructive answer to those questions
and help them guide theirportfolios through some uncertain
times.
Very good. Well, as you say,we're living in very uncertain times
and the day-to-day volatilitywe're seeing at the moment is immense.

(07:36):
But, I guess for today'sconversation we're going to take
a step back, and take a lookat the big picture, and see what

(07:57):
we can infer from the bigpicture. So,Elroy and his co-authors
are the author of the GlobalInvestment Returns Yearbook. As Elroy
mentioned, it started off asthe Millennium Book and then became
quite a well known publicationor hardcover book called the Triumph
of the Optimists. And thenit's been published every year since
then. Imean,you gave a senseon how it originally came about,
Elroy. I guess, when you didit first, did you imagine that you
would update annually and itwould become such a kind of a reference
book for people?
No, the evolution was kind ofa surprise. We thought there were
some really big questionslike, has America been so unusual

(08:27):
that the common basis forestimating long-term returns may
not work? It may relate to onecountry's history and that may not

(08:50):
be true of other countries.So, we thought that looking at long
term stock market returns andlooking at the equity risk premium

(09:14):
for a range of countries wouldbe informative. Wecalled the book
Triumph of the Optimistsbecause it became clear that the
optimists, the people whobought risky assets back in 1900
had triumphed. But we didn'trealize that there are lots and lots
of other questions that wecould use to confront data, and we
could get answers to othersorts of important questions, and
there's been a lot of them.So,we started out with a book which
we thought dealt with a bigquestion and answered it. We ended
up with a data set, and a dataset which has grown over the years,
that we could use to answerall sorts of other contemporary questions.
That's right. And obviouslyeach year I think you've taken some

(09:38):
interesting themes and topicsand delved into those, and we might
get to some of those as well.Kiran,I'm just, just curious. Obviously,
UBS have now partnered withDEEM in this respect. It was Credit
Suisse previously. I mean,from your perspective, when you engage
with clients around this, whatkind of feedback challenges do you

(10:01):
get? Imean,sometimes you'llget the view, well, you know, what
happened 100 years ago, howrelevant is that for today's market?
But equally, I guess, it'sinteresting to anchor to kind of
returns that we've observedover the long term. I'm just curious,
what kind of feedback do you get?
Yes, I think firstly to saythat this is one of the most popular

(10:32):
reports that we issue eachyear, and really proud to partner

(10:56):
with Elroy and his colleagueson this. Clients really have a very

(11:21):
strong appetite for trying toanchor their decisions in the long-term.
Ithinkexactly as Elroy said,the fact that we are able to not
only show US data, which isquite commonly available, but also
make the case by showingcertain things that work across a
whole variety of differentcountries, I think that really helps
us make the case around someimportant investing principles. So,
I think that's reallyimportant for clients. Literally,just
this morning, I was talkingabout the yearbook with a large group
of clients from Latin Americaand they were asking many questions
around things like realinterest rates, or correlations between
equities and bonds, orprospective returns for equities,
or the equity risk premium.These are all very, very topical
questions and sometimes wehave to be honest that we don't always
have a very clear answer aboutwhat things are going to be like
in the near term. Butbeingable to at least ground those conversations
in longer term data, longerterm norms, understanding different
regimes we can enter, reallyhelps frame the conversation and
frame the reference so thatthen our clients are able to make
decisions using certainparameters for their investment portfolio.
So, I think, really, it’s avaluable study. People use it for
a wide variety of purposes.But just having that breadth of country
level data and the time spanreally makes it a very powerful set

(11:42):
of data.
Sure. And, I mean, when youlook at the numbers, do you find
that investors are surprised?(We'll get into some of the details
in a bit.) I mean, say, interms of the size of equity returns
outside the US, maybecertainly not as strong as what we've
seen in the S&P 500 over thelast few years, is that more sobering

(12:04):
for people or how did it takethose kind of perspectives?
Yeah. So, I think one thing ison the power of compounding, which
we know that Buffett is calledone of the wonders of the world.
But I think that really comesover such a long time span because

(12:31):
you can see differences eitherin asset returns of maybe a few percentage
points, or between countriesof maybe 1 or 2 percentage points.
When you look over that verylong timespan, it makes a massive

(12:51):
difference to wealth. So,particularly for our clients who
are thinking on amulti-generational time frame, that's,
I think, an interestingillustration for them. Andthen,
look, it depends where clientsare coming from as to whether they're
sort of surprised positivelyor negatively about some of the prospective
returns in other countries.But we found that the study really
does show the importance andthe power of diversifying globally,
and the importance and thepower of making sure you have a strong
allocation to equities becauseof the scale of the outperformance
you get over time.
Absolutely. And I guess,Elroy, the outcome, the results are
very much consistent with theother well-known book on this called

(13:15):
Stocks For the Long Run. Imean, this is the message here as
well, that you show theoutperformance of equities over bonds,
and over bills or cash, over along period of time, notwithstanding
some pretty dramatic drawdownsalong the way. I mean, that, presumably,
didn't come as a surprise toyou. Or did the magnitude come as

(13:36):
a surprise to you when youstarted doing this research?
Well, the book entitled StocksFor the Long Run, written by Jeremy

(13:59):
Siegel, professor at theWharton School, in the US, was when
we began a very influentialvolume. So, in the end of the 1990s,

(14:35):
I was going to the US fromtime to time and every cab driver

(14:56):
in New York would tell youabout their plans, what they're planning
for the future. There'd be abig wedding for the daughter, a Bar

(15:33):
Mitzvah for the son. Itwasall going to be very ambitious, but
everything was under controlbecause it wasn't for another 10
or 15 years. And they’ve gottheir money invested, and they've
got it invested in commonstocks. And that was going to produce
the high return that wouldenable them to manage their aspirations.
Andthen the tech bubbleburst. We went through an experience
which is not dissimilar to thethings that people are worrying about
now. And it wasn't quite soclear that a recipe for your financial
future is simply investing incommon stocks. So, there are these
differing points of view. Youmight be cautious, or you might be
focused on equity risk.Andour thoughts on that have evolved
over time. But it did becomeclear, as we looked at lots of countries,
that the US had doneremarkably well and that in other
countries you had to hold forfar longer than your daughter's wedding
if you were to become wealthythrough investing in common stocks.
So,for me, probably for you,having a balanced portfolio makes
more sense than plunging veryheavily into one asset class and
BAPS selected components ofthat asset class.
That's interesting, I mean,because even today the standard view

(15:57):
is equity heavy. And obviouslywe've had a period, a 15 year period,

(16:20):
that's been particularlyfavorable. So,you touch on US exceptionalism.
When you look at that outcome(and I don't have the numbers to
hand), the nominal return inthe US equity market is about 10%,
I believe. And outside of theUS it might be 2% or 3% less than
that or something like that.And as Kiran says, when you compare
that over time, that is quitea dramatic difference. Whenyou look
at that, is that a reason tobelieve that would be the case in
the next 100, 125 years, or isthat just one 125 year sample in
the fullness of time?
When we published our work inNew Year 2000, in this pre Triumph

(16:49):
of the Optimists volume, whichwe called the Millennium Book, we
had the history for the wholeof the 20th century. And two features

(17:30):
were very prominent in all ofthat. Onewas the remarkable performance
of common stocks, and theother one was the remarkable performance
of the United States. And so,looking forward, we would not have
expected, in the 21st century,to see common stocks doing quite
so well as they had in thepast. And that we were correct on.
Andwe would not have expectedAmerica to continue to be world beating
compared to other markets. Wewere wrong on that. America has had
a marvelous quarter centurythis time around. The last few months
have become a bit more of apuzzle. But the first 25 years of
the new millennium have beenvery favorable for the United States.
And so, one of the thingswhich we might come back to later
on is what we think willhappen for the future.
Yeah, absolutely. Kiran,Imean, that is a topical point at
the moment. We've had thisstrong outperformance from the US,

(17:56):
and capital has been flowingin, and obviously (we're recording
this in the early April) we'vestarted see cracks in the American
exceptionalism story. How,howare you finding investors are balancing
that kind of 25 year or 125years of US exceptionalism versus,
you know, a few months of underperformance?
Yes, well, I think in recentyears the US has had almost everything

(18:32):
going for it because it's beenan economy with somewhat higher growth
than we've seen in otherregions. It's also been perceived

(19:01):
as a safe store of money. Andit's also had a lot of the biggest
and fastest growing companiesand the companies with share prices

(19:34):
appreciating mostdramatically. And if you're in the
startup space, it has also hadthe most interesting venture capital

(19:59):
opportunity. So, it's hadpretty much everything going from
it from growth, to safety, toeconomic performance. Andobviously
now we're getting some cracksin that, whether it's uncertainty
about some of the businessmodels on the AI side, obviously
some of the politicaldisruption that we're seeing. So,
we're seeing some cracks inthere. Ithinkwhen we're talking
to clients about what mighthappen over the longer term, I think
it's important also toremember… And this isn't from the
Global Investment ReturnsYearbook, but this is a study that
was cited in there fromHendrik Bessembinder, from Arizona
State, which shows that theperformance of equity markets is
of course heavily driven bythe individual companies that compose
them, and not just theindividual companies in aggregate.
It's a very few individualcompanies that really drive the majority
of the growth over the longerterm. So,I think we also have to
be somewhat humble about ourability to predict, over the next
hundred years, what are goingto be those dominant companies of
the future and in whichcountry will they reside. And the
US has done fabulously, in thelast two decades, because the technology
giants that now dominate theequity markets were founded and grew
in America. In the nextdecades, maybe it will still be in
America, maybe it will besomewhere else. Idon'tthink we
can have a clear view or wesay to our clients, is that you just
need to be diversifyingbroadly across all of these markets
to make sure you're notmissing out on the next Nvidia or
Amazon or Apple or some ofthese great companies of the future
that will be really dominantin driving portfolio returns.

(20:22):
Absolutely. And it does seemthat investors tend to extrapolate
from the recent past andassume that the world will continue
to be dominated by the Mag 7.But Elroy, as you show in the book,
you show one notwithstandingthe high level of concentration in

(20:42):
the US, it's not thatconcentrated relative to some non
US indices. And also, you showthat we've seen it more concentrated
in the past. And you also showhow dramatically things change over
time. If you go back to 1900s,the index was very much concentrated

(21:03):
in railway stocks, isn't thatright? So,I mean, it sounds like,
in reading the book, you don'tseem to be overly concerned about
the concentration in the US market.
Well, let's think a little bitabout the way that we visualize concentration.
Typically, it's the proportionof a particular national market that's

(21:33):
allocated to particular stocksor particular sectors. And the United
States is not internationallyunusual from that point of view.

(21:56):
However, it is very importantbecause two thirds of the world's
equity market, at least at thetime that we published our book,

(22:22):
and certainly well over halfon the worst days we've had recently.
So, the majority of theworld's equity market is the US.
Sowhat we have is amoderately concentrated United States.
We have a moderatelyconcentrated World index. And that
means that we are exposed towhat's important at present, which
is certain types of techstocks. That's perhaps not very different
from 1999 when there weresomewhat different tech stocks that
were important, or the 1970swhen energy stocks were very important,
or going all the way back torailways, as you've done, or even
canal stocks, if we go backessentially before that, but if we
think about the industriesthat have provided growth, though

(22:44):
not necessarily stock marketperformance. China,of course, is
now creeping up very fast. Andwho knows whether the next century
will be the century for Asiaor whether the United States, with
its unusual economicattributes, will resume powering
ahead of the rest of the world.
Yeah, I mean, I guess that'sthe way investors look at it. I mean,
you can (I guess, withoutrunning the risk of putting a narrative
exposed) you look at the US -it is business friendly, low regulations.
So, I guess people might notbe shocked to see that the US has

(23:08):
been the best market. Wouldyou agree with that or are we just
applying that…
No, no, I don't agree withthat interpretation at all.
Okay, okay.
The general view has beenbusiness friendly, and the rule of

(23:28):
law, and so forth. If that'sthe case, that would make the US
low risk. And if it's lowrisk, it should have been low return.

(23:54):
So, if I was taking adifferent interpretation from you,
I think I could justify that.Andso why has the US done? Well,
it surprise is because wemisjudged the degree of innovation
in the country. We failed toappreciate the ways in which it might
benefit, amongst other things.And thinking about the current turmoil,
from benefiting from low costalternatives externally and building
new businesses and newinsights internally within the United
States, we underestimated thegrowth dramatically.
Yeah, I mean, Kiran touched onthe point about the small number

(24:23):
of stocks which has driven theindex returns and has emphasized,
obviously, the importance ofdiversification. So,presumably when
you think about that, I mean,I don't know if it's explicitly a
message, but it seems to be achallenge for individual investors
to try and identify those. Andagain, it's further support for indexing,
I guess, isn’t that fair to say?
Well, usually when there's newinvestment evidence, one side of

(24:45):
the active/passive debatecites it and the other side tries
to take a contrary view. Butwhat we've gone through lately is
one in which there's the samebody of evidence, that is these very
large companies which haveperformed extremely well. And you

(25:09):
find the passive managers areciting the evidence saying, well,
if you want to get your shareof the good performers, you've got
to be well diversifiedotherwise you'll leave them out of
your portfolio. And the activemanagers are saying it all comes

(25:33):
from a few stocks. Get thestocks right and you'll do very well.
Andso, this story of theimpact of concentration and of concentrated
performance within largecompanies, both active and passive
managers, find support fortheir favored way of managing portfolios.
Yeah, interesting. And I meanfrom the perspective of risk, you
said, okay, if you're safer,maybe it's less risky. I mean, how
should we think about therisk? Obviously, some people use

(25:57):
volatility, standarddeviation. I guess a lot of people
in the wealth managementcommunity will point to the statistics
around it that if you linkedin the holding period for equities,
you've reduced the likelihoodof having a negative outcome. And

(26:17):
I think the longest you had towait was 16 years or 18 years if
you immediately went into adrawdown. Imean,if you're looking
across different equitymarkets, how do you think in terms
of ranking them according to risk?
Well, if we ask ourselves forhow long could you be underwater,
that is producing returnswhich after adjusting for inflation

(26:40):
are negative? Yes, the US, 16,17 years was long enough over a very
long period in history. Butthere are other countries where you
would have got left behind fora very long time and where, in some

(27:01):
cases, if you were investingjust in that country, you'd have
been waiting 50, 60, 70 yearsjust to break even. And that's without
incurring any costs fromreinvesting dividends or asset management
fees. So, the US had this veryfavorable story. Ithinkthe bottom
line from that is that wedon't know which countries are going
to be the ones that performwell and which ones will not. And
so, diversifying acrosscountries, across asset classes,
and over time makes sense.

(27:24):
Yeah. And in terms ofdrawdown, obviously, in the last
125 years, we've seen theGreat Depression where stocks fell
by 75%, 80% in real terms.We've had at least two episodes of
50% declines. We've had thedecline in ‘73, ‘74. So, there's,
what, four or five episodes ofkind of 50% plus declines. So, should
we expect one of those, onaverage, every 20 years or so, or

(27:48):
what would your guidance bearound that?
Collapses of a big nature aremore likely when people feel they're

(28:11):
in good times, when they feeloptimistic. Because when you feel
optimistic, you're willing tospend more on getting exposure to

(28:44):
the stock market. And thatmeans quite small changes in growth
expectations can have a biggerimpact. That'swhy the shift from
‘98,’ 99 through to 2000, 2001was dramatic because people thought
the risk had gone down andgrowth expectations had gone up.
So, despite the turmoil thatwe've been going through in March,
April of this year, I thinkwe're still in quite good times.
The world is in much bettershape than it was many decades ago.
And so, we should expect bigcollapses with a greater frequency

(29:06):
than one saw early on.Bigcollapses, say, in the periods
prior to world wars, werepreceded by people feeling pretty
glum anyway, so there wasn'tthe scope for a sudden decline of
huge impact in the stockmarket. So, I stand by the diversification
mantra as being very important.
I mean, speaking ofdiversification, bonds are the typical
diversifier historically forequities. But there's a lot of interesting
information around bonds. Itstruck me, you know, some of the

(29:27):
drawdowns, in real terms, forbonds have been very stark. We can
also talk a little bit aboutthe bond equity correlation. But
it seems unusual, I mean, ifyou look around the world, pension
authorities have been kind ofencouraging corporate and pensions
to invest more in bonds overthe last couple of decades. But when

(29:48):
you look at your outcomes, youknow, you can get quite negative
real returns in bonds forquite long periods. Does that surprise
you?
Yeah. So, if we look at thedrawdowns that is the decline we

(30:21):
always look in inflationadjusted terms. So, the decline in
real terms from a high, andhow long it takes to return to that

(31:06):
previous high, the periods ofbeing underwater - of being cumulatively

(31:26):
in negative territory, havebeen much greater for the bond market.
So,if you chose the wrongtime to invest in government bonds,
you could be struggling for avery long time, and in some cases
for an indefinitely long time,if you had been in Germany or Austria
at the wrong time. So, whatyou see is that there have been very
dramatic drawdowns. And therecovery time for equity markets,
after a big setback, has beenshorter than the recovery time from
bonds. But that, in part, wasto do with high inflation rates that
we had over the last severaldecades. Inflationrates alleviated,
interest rates moved fromsubstantial double-digit levels down
to about zero. They've gone upa bit now. They're more like what
we might have expected a fewyears back. Sothe scope to make
money from interest ratesdeclining and bond prices improving,
that was something whichrepresented several decades prior
to 2022. That can't berepeated. Theextreme variability
of bonds for a long-terminvestor, I don't think is as extreme
as it would have been if wehad been thinking in 1970 or 1980
as to what we would do withour fixed income investing. Kiran,
you may have a differing viewon that. I don't know.

(31:47):
Yeah, so, I mean, I think whenwe're thinking about how to manage
through drawdowns, at leastfrom a private wealth context, it

(32:08):
depends as much around thepsychology of the investor as it
does on the market itself. So,what I mean by that is if we see

(32:30):
that, historically, equitieshave had periods where they've been
underwater for 5 years, 10years, up to 15 years, we can use
that to think about, well, ifinvestors can keep an allocation

(32:59):
to safer assets like fixedincome (and I'll come on to why we
would consider those to besafe), then psychologically they
can sometimes get their waythrough some of these drawdown periods

(33:28):
because they have that fixedincome allocation to draw on during
the periods when equities areunderwater. And it will give them
enough time for them torecover, at least if we see drawdown

(33:58):
lengths of historicalaverages. Andon the fixed income
side, I think there's maybe,from a private wealth context, two
ways to think about bonds. Theone is where you have a fixed duration
(which is what was looked atin the study) of perhaps 10 years,
perhaps 20 years, and then itcan act as something of a diversifier
to the equity portion of theportfolio. But of course, you can
also look at fixed income orbonds from a maturity standpoint
and think about, okay, well,next year I want to spend £10,000,
so I'm going to invest £10,000in a gilt. And then it's almost risk
free. You're inoculatingyourself against interest rate risk.
You're going to get that moneyback in a year's time. Youcan do
the same in two years, threeyears, four years, and you have this
bond ladder. So, from a wealthperspective, you can often build
diversified portfolios indifferent ways. You end up, in aggregate,
with a stock and bond mix.Butfrom a psychological perspective,
having that bond ladder aspart of the bond component can give
investors more confidence toallocate their sort of longer-term
portfolio more towardsequities because they know that their
spending is quite well securedfrom that bond ladder in the near
term.
It makes sense. You have achart in the report about the bond/equity
correlation going back all theway over the 125 year period. And

(34:22):
it shows very clearly thatbond served as a fantastic diversifier
in that 30, 40 year periodfrom, I guess maybe, the 1990s up
until recently with thatnegative correlation between bonds

(34:47):
and equities. But it does verymuch stand out as an outlier in the
context of the overall 125years. Obviously,we've seen bonds
and equities become morepositively correlated. I guess it’s
impossible to say what thenext 20 or any period of time.. But
I guess it does highlight, asyou were alluding to Elroy, that
period we've been through,kind of from 1980 to 2020, was unusual,
and fixed income conditionswere unusually favorable, I guess,
with falling inflation and howbonds fitted with equities.
Well, bonds had an importantrole in a mixed portfolio and that's

(35:39):
why people talk about 70/30 or60/40, institutional or high net

(36:11):
worth portfolios. And then thefirst couple of decades of this millennium

(36:45):
was different. PaulMarsh andMike Staunton and I believe that
we are back to where we werein 1999, when we were looking back,
and that the role of bonds asa diversifier with lower expected
returns but attractive riskdiversification properties are there.
Quite how much you shouldinvest does depend on the taste of
the individual. Kiranisidentifying one part of this. Another
one which financial advisorsfocus on is how much you ought to
invest if you are young,middling, older. But the people who
are older sometimes have thegood fortune of having more money
than they're going to be ableto spend on themselves. And so, their
time horizon should be long.It should be the time horizon that
is appropriate for theirchildren or grandchildren, or for
the charities they wish tosupport, whichever way they're going
to spend the money. So,somepeople, as they get wealthier and
older, should be thinking moreabout what would make sense for them
for the long term. And thenthere's others who should be thinking
about what they need for 5 and10 years time - the way Kiran was
describing it, in terms ofpersonal needs for expenditures.
Yeah, well, we've obviouslyseen that bond equity correlation
change, and a lot of that camefrom 2021, 2022, when we had this
spike in inflation. And youalso review inflation over long periods
of time as well. I mean,notwithstanding, I suppose, current

(37:08):
central bank targets of around2%. I mean, the historical experience
of inflation around the worldhas generally been higher on average
than that, isn't that right?
Well, inflation has beenincredibly important, and so important
that when we compare differentcountries, we always do it either

(37:29):
in inflation adjusted terms orin common currency terms. But then
when we switch into a commoncurrency, we are adjusting for the
inflation differentialsbetween countries. So yes, inflation
is incredibly important andthat's why we present all of our
data in real terms.
And I think for the US overthe full period, inflation averaged

(37:52):
about 3% or so, maybe 2.9% orsomething like that. So, I mean,
that would seem a reasonableexpectation going forward, or what
would you say?
Yes, I think that's whatpeople are currently thinking about.
But over the weeks we've beengoing through recently, I think all
bets are off for projections.And so one of the other issues which

(38:15):
gets to be important is whatshould you be doing if you're no
good with projections, ifyou're just concerned about the downside
or wanting to maximize theupside? That's the area that UBS
would be focusing on, notespecially Paul Marsh and Mike Staunton
and Nick.
Yeah, and in terms ofinflation, you've looked at how different

(38:37):
asset classes perform ininflationary periods and which are
the best asset classes todiversify into. And broadly, it's,
I guess, not surprising thatcommodities do well. Gold is seen
as a good inflation protector.I'm not sure if you call it as an
inflation hedge. And likewise,equities over time have outpaced
inflation, so have been a goodstore of value too. But my reading

(39:01):
is you wouldn't call them aninflation hedge.
Well, to us, a hedge is anasset which gives you a return that
moves in the oppositedirection to inflation, so that if
inflation is high, it performswell, so at times we've looked at

(39:22):
different novel sorts ofassets. So, wine can be an inflation
hedge, so can investmentquality postage stamps. If inflation
gets to be bad, I probablyprefer to have the wine bottled versus
postage stamps.
The thing is, the point on thehedge is an interesting one because

(39:52):
I was speaking to some clientsthis morning around this and I was
showing the chart that's fromthe Yearbook showing the positive

(40:13):
correlation betweencommodities and bonds and inflation,
but the negative correlationthat inflation linked bonds and equities
have demonstrated withinflation. We got into quite an interesting

(40:37):
debate about well over whatperiod am I trying to hedge the inflation?
Becauseif you're trying tohedge it on a sort of few months
basis or a one year basis,then the gold and the commodities
have proven to be better. Ifyou're trying to hedge inflation
on a 5 year or 10 year basis,then you want to be invested in assets
that are going to outpace itor at least match it, in which case
then the inflation linkedbonds or the equities certainly are
the better asset class. So, itsort of depends a little bit in terms
of your portfolio, yoursituation, or your withdrawals, or
what exactly you're trying tomanage, whether you should be allocating
a bit towards the gold andcommodities to hedge in the short
term or you should be moretowards that sort of equity and inflation
linked space to outpace it inthe longer term.
Makes sense. I know anotherone of the studies you've done, at
one point, that you update nowis around regimes. And one of the

(40:58):
types of regimes you identifyis the interest rate environment
where the rates are falling orrising. And the differences in returns
are quite stark, certainly inequities, but I think probably across
all the asset classes. I'm notsure if you can recall the numbers,
but I mean, certainly most ofthe returns for equity I think come
from falling rateenvironments. Is that right?

(41:21):
Absolutely. It is strikingthat in different monetary conditions
you don't find the samepattern for equities and for bonds
and that when the Fed, in theUS. or its counterparts in other
countries have been kind toinvestors, there's been a favorable

(41:45):
outcome for equities and thatthe equity risk premium does not
accrue steadily throughouthistory. It comes about when interest
rates have dropped.
And I mean, taking that lensat the moment, Kiran, I mean we're

(42:14):
in a little bit of anuncertain period. We'veobviously
gone through a period ofrapidly rising interest rates and
then rates have come off alittle bit, but kind of hard to infer,
you know, structurally, are wein a kind of a generally rising or
falling rate? So, from a UBSperspective, how do you incorporate
that into current process?
Yeah, so, I think if we lookat where real interest rates are

(42:40):
today and you look at the verylong-term study from the Global Investment
Returns Yearbook, we're notmassively out of line with the long-term

(43:11):
averages, about somewherebetween 0% and 1% as a real rate.
That's quite well lined upwith what the Fed is telling us as

(43:41):
their long-term expectationfor the real rate. So,I think that
is sort of making it unclearas to which direction do we go longer
term? Of course, on theshorter term and tactical horizon,
I think, in recent yearsinvestors have grown used to the
idea that Elroy expressed thatwhen the Fed is cutting interest
rates, or when the Fed isintervening in markets, or when the
Fed is trying to supportfinancial stability, markets go up
and they struggle to go upwithout that. AndI think if you
translate that onto today'ssituation, obviously there’s a lot
of uncertainty in markets andwe would say that one of the prerequisites
for a sustainable recovery,not the only thing that can happen,
but one of the prerequisiteswould be the Fed coming in with either
faster than expected interestrate cuts or some kind of package
to guarantee financialstability through this period. And
we see the volatility in thetreasury markets today. So,I think
that long-term idea, thatElroy expressed, that markets do
well when the Fed is cuttinginterest rates or when central banks
are cutting interest rates, Ithink really does hold over tactical
horizons as well.
Absolutely. You cover themajor asset classes and you touched
on some alternative assetclasses there with wine, et cetera.
I mean, the growth of cryptohas been one of the features of the

(44:02):
last decade or so. It's stilla new. I don't know if you would
call it an asset class or ifyou would group it in with currencies,
but how do you think about thelikes of Bitcoin? And you know, looking
back over 125 years, have weseen similar episodes of new asset
classes emerging and thengoing away, or is this something

(44:23):
very different?
I think when you go back inhistory and you want to look for

(45:09):
crypto assets, you have to bea little bit broad minded about how

(45:49):
you interpret history. Therewas a time, which is well documented

(46:23):
by a couple of economichistorians who looked at the prices

(46:58):
of artworks during the run upto the early stages of the Second

(47:38):
World War. Andit turned outthat one of the deciding factors
that makes a difference is thesize of the artwork. The bigger it
is, the less it's worth,because people wanted to be able
to roll paintings up, stickthem down their trouser leg and try
to escape whichever countrythey were in. So, it was a sort of
crypto asset because it couldbe moved unobtrusively. So, there
can be utilities from havingparticular sorts of assets. So crypto
is fulfilling some of the rolethat gold had, but also has extreme
anonymity. It's a difficultquestion. Igoperiodically to a
meeting of people who areinvolved in endowments, some of them
university endowments, andsome are charitable endowments. And
we were discussing asset mixat our last meeting just a few weeks
ago. The person who waschairing this meeting went round
endowment managers, someresponsible for very large endowments
and some for medium sizedendowments, asking about their attitudes
to crypto. Every single personsaid they wouldn't touch crypto with
a barge pole. So, when I gotback to my office, I looked up some
of these people. One of themis Cambridge University, my employer.
There, on the website, it'smade clear that they accept donations
in crypto and have no problemwith that. Andthen I looked at who
are the big philanthropists,and there's an estimate of the magnitude
of philanthropy from cryptopeople, which over the last few years
has totaled $5 billion US. DoI believe that? I don't know. I have
no way of verifying that. Butthere are a number of crypto enthusiasts.
So,I went back to my groupand said we really should talk about
this again at our nextmeeting, which is in May, and see
what our attitude is a littlebit more deeply, because many people
are invested in common stocksor investing, in fact, in companies
which are involved with cryptoand many of them will handle crypto
donations. So maybe we wereall being too narrow-minded on all
of this. It'sa problem. But Idon't think that by just saying it's
a gentle idea that we can sortthe world out. Maybe that's too many
middle-aged people who arebeing negative about ideas which
belong in our children's generation.
We've been thinking from aportfolio perspective as well, that
sort of in a classic riskreturn Sharpe ratio maximization

(48:10):
framework, it's very hard tomake an allocation to crypto make
any sense because thevolatility is just so high. It just

(48:38):
dominates the rest of theportfolio. But we know that for a
lot of private individuals,that isn't the framework that they're

(49:06):
using to think about theirportfolio. Someof them have more
of, perhaps a returnmaximization framework. And then
thinking about an asset thathas the potential to do almost anything,
that can sort of make sensementally in that sort of framework.
And equally, I think thatcertain high net worth individuals
will have quite a differentattitude to the way we classically
think about risk. So,in aninvestment framework, we often think
about risk in terms ofvolatility or potential drawdowns.
They may think more in termsof potential event risk in the world.
And Elroy mentioned wars andartworks. And those clients who think
more about risk in those termsmight value assets like gold, like
our work, like wine, likecrypto in that context, as a hedge
against those types of risks.Maybeit's handy that you've got
a crypto portfolio or somegold in those types of events, because
you're probably not going tobe looking at your standard deviations
anymore when those kind ofthings happen.
Sure. But has it been viewedlargely in those terms as a defensive
holding store of value or, forsome people, it's behaved more like
a growth risk asset of late?

(49:27):
It's both. So, as I said, someclients will be looking at this from
a return maximizerperspective. They want something
that has the potential todouble or triple. That's the kind
of things that they look for.And others are holding it in the

(49:49):
spirit that they hold gold orartwork and that. So, it's a variety
of use cases. AsI said, itdoesn't make a lot of sense in a
classic context, but when youthink about it from just different
ways that private individualscan look at these assets, then it's
not totally irrational.
And Elroy, the other area ofthe investing world where you devote
a couple of chapters and wherewe've seen very big growth is the

(50:11):
area of factor-based bestinvesting and what you might call
smart beta. Some interestingresults in the study from that side.
Yes, factor investing hasbecome very popular. Factor investing
deals with exposing aportfolio to the performance of particular

(50:33):
sorts of factors, such as therelative returns from value stocks
compared to growth stocks, orpositive momentum stocks - companies
which are going up in pricerather than declining, or small cap

(50:56):
stocks versus large capstocks. There are a number of these
strategies, Altogethereconomists have identified many hundreds
of them. But almost all ofthem will evaporate if you look afterwards

(51:18):
and see whether a good ideaactually persists and will work in
the future. Butthere areprobably half a dozen of these factors
which are thought to beimportant and are thought to provide
a reward to investors,possibly for risks that they are
taking, but a risk premiumnonetheless. And so, evidence-based
investors look towards loadingup their portfolios with exposure
to particular styles ofrunning the portfolio.
Yeah, interesting. And you dopoint out, in the study, about how
investors tend to surge into aparticular factor after it's done
well and the return premiumsare maybe not fleeting, but they're

(51:41):
certainly not consistent overtime. Isn't that fair to say?
I think that is fair to say.Some people would then say, well,
why not have a diversifiedportfolio of these exposures? And

(52:12):
I think my answer to thatwould be yes, if you're putting together
a number of ETFs orspecialized funds, certainly diversify

(52:37):
them. But actually, it's notobvious that multi-style, multi -actor
packaged products, singleproduct from a single supplier, will

(52:59):
do the trick because thenyou're relying on that supplier's
capacity to put together afactor portfolio which suits you.
Butthis is a growing area,and investors should take account
of factor exposure for atleast two reasons. One is there may
be a risk premium that'sinvolved. And the other one is that
many investors unconsciouslyexpose a portfolio to particular

(53:19):
styles. So,for example, ifyou believe in always having a tidy
portfolio that does notcontain stocks that have dropped
in price, that might be truefor some asset managers. Then what
you're doing is selling out tostocks which have been falling in
price and you've got to put itback in others that have been going
up in value. Those are allfactored strategies. And you need
to understand factor investingeven if you are pursuing a strategy
which is not directly drivenby factor risk premiums.
Yeah. And as you say,momentum, or kind of chasing the
winners and selling thelosers, based on your data, seems
to have done very well overtime and particularly well in recent
years. But even going backover longer periods, I think it was
the strongest factor, if I'mnot mistaken.
Momentum has done well. That'sabsolutely correct. It is not a cheap

(53:45):
factor to implement because ifyou buy into a stock which has gone
up in price, well, after awhile it will have gone up and you're
going to have to sell it tohave the money to go for another

(54:12):
stock which has gone up inprice. But it involves turnover.
Turnover is costly, so I thinkthe evidence is fairly compelling.
But over long periods,momentum has done well even after

(54:33):
costs. But it's not a cheapone to follow. It'sdifferent from
say, buying small cap ratherthan large cap stocks, where sadly,
if you bought a bunch of smallcap stocks this year, they'll probably
mostly be small caps next yearbecause they won't run that well.
But then you at least hangonto them for the following year
and the year after that. Sothat's a lower turnover strategy.
Yep. And I mean, some of thesefactors or some of these approaches
have struggled of late. Likevalue being the obvious one, has

(54:56):
had a kind of a prolongedperiod of tough performance. And
now people suggest, oh, maybeit's the end of value investing as
we know it. ButI mean, you doplot the returns of the various factors
over time through differentdecades, and they come and go. So,
would you see that kind ofunderperformance of late as just
normal statisticalfluctuation? Or do you think there
might be something in thatview that value investing has become
structurally more challenged?
Well, value investing involvedbuying stocks which look cheap on

(55:20):
fundamental grounds and beinglight on growth stocks. And if we
look at the last half decadeor decade, those growth stock contrast
to the ones that you, withhindsight, would wish you had held.

(55:42):
So, there is an investmentdecision that's buried in all of
that. Thosepeople who aresaying that growth stocks have now
reached their peak and maybeeven got past that peak, then for
them, this is the right timeto be investing in value.
Okay, so maybe tyingeverything we've talked about together
with an eye on the future andthinking about projected returns.
As you say, when you wrote thebook first, at the turn of the millennium,

(56:03):
you were, I guess, morepessimistic than the market based
on the fact that returns hadbeen very strong and just preceding
that. I mean, where are wenow? Or what would you say are the
expectations in the majorasset classes? What kind of order
of magnitude should we expectgoing forward?

(56:24):
I think we should continue toexpect some reward for investing
in equities compared to bondsand a small reward for investing

(56:45):
in longer bonds compared tocash or short-term exposures. My
take on it would be that theequity premium, the reward you would

(57:07):
get compared to bonds would besomething of the order of 2.5% to
3% per year. But people shareour data, we're very public about

(57:30):
that. And others will havesomewhat different views. Butif
I look around at theendowments that I was mentioning
earlier, some of them willhave spending rules of CPI plus 4%.
That's a little bit on thehigh side, but there are some that
are still willing to spend 5%.I think if you spend 5%, you will
be quite challenged tomaintain the real value of your portfolio.
And so, my college atCambridge is closer to the 2.5%,
5% level in terms of spendingafter adjusting for consumer price
inflation.
Yeah, so I mean, you mentionedthe work you're doing with the endowments,
and, I mean, I’m curious toget your perspective on their approach
and maybe your own thoughts. Imean in terms of constructing a long-term

(57:52):
portfolio, obviously it'sequity centric, I guess. But you
do emphasize the need fordiversification. So what would be
if you were the broadparameters or the broad outline of
an asset allocation, do youthink that would be appropriate for
a relatively long-term portfolio?
Your audience includes somewho, like those involved in the endowment

(58:24):
world, are concerned tomaintain value for a long time into
the future. And it alsoincludes individual investors or

(58:56):
high net worth investors. Myguidance for people who are at the
sort of moderately comfortableend of the spectrum is that you should

(59:33):
invest in the highest returnassets, which is education. Forthe
starting point would be thatmoney spent on educating your family
or if you've had the goodfortune to become wealthy, educating
other children, that is moneythat's well spent. When it comes
to investing for thelong-term, if you don't have immediate
spending needs, yes, I'msomebody who leans towards equities.
The taste that I will have maydiffer from UPS's. I'm relatively
tilted towards a passiveinvestment. Icanfind that other
things apart from investing tospend my time on. So, I prefer to
leave others to get on withorganizing my portfolio for me and
just buy a bit of everything.Butyou know, going back to my example
of the esoteric things thatwe've looked at over time - artworks,
wine, and so forth, if you getsome pleasure, you'll receive less
financial income, but you mayhave more psychic income from some
of those assets as well.
Yeah, and we haven't touchedon property much at all. I mean my
impression is for a lot ofhigh-net-worth investors the they

(59:54):
do like owning bricks andmortar, particularly here in Ireland
it's definitely the case.Where does property fit into that
framework?
Residential property is in thesame category as wine and artworks.

(01:00:16):
That is you receive somethingwhich is a benefit that you value
personally. There's anincreasing volume of academic research

(01:00:41):
on private assets which giveyou private enjoyment. So, buying
your own home gives you adividend which exceeds what you would

(01:01:09):
be paying if you were rentinga similar place that was produced
to somebody else's taste.Asan asset class, we can be thinking
about commercial real estate,but we are cautious in what we write
about long-term investmentreturns from real estate because
the number of good qualitystudies that go back a long way in
real estate are limited.There's very little data going back
more than about 40 years.Weknow that if we were looking at
bonds we wouldn't settle forjust the last 40 years because that's
the time that interest ratescame down and bond prices went up.
Well, we shouldn't be lookingat just the last 40 years for commercial
property, which is sort of ifit's high quality, it's a bit like
a bond with a bit of addedequity kicker. We would like to have
125 years as well for that,but there are only a few studies
that go back that far.

(01:01:30):
Okay, great stuff. Well, it'sa fascinating study. For people who
want to read the report or getaccess. How can they do that?
They can either email me, butI'm not going to sort of start leaving
details that nobody, whiledriving their car, can get here.
I'm happy for people to writeto me. My addresses are on the web

(01:01:54):
all over the place - ElroyDimson. Or if they come through to
you, I'm happy to respond toquestions that listeners send my
way. And it may be that thebetter qualified co-author is Mike
Staunton or Paul Marsh. So,the amount you can reply from that.
Very good. Well, we willinclude a link to the study in the

(01:02:18):
show notes so people knowwhere to have a look for it. But
Elroy and Kiran, thanks verymuch for coming on today. It's been
a fascinating conversation andvery valuable information, I think,
for all of us in terms ofconceptualizing what we should expect
from asset market returnsgoing forward and understanding the
past. So, for all of us here,thanks very much and stay tuned.

(01:02:41):
We'll be back with further episodes.
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