A different model
Stockbrokers, rich themselves like their clients, knew that investment was about purchasing income [on which to live], as well as gambling for fun, and gain. This was the basis of what was later known as the Fed model: 40 per cent bonds for living expenses and 60 per cent shares for lower income and some hopes of capital profit.
The reality of investors’ desires is evidenced by the history of the past 10 years. The more that central banks pushed money into the markets, driving down yields on cash and safe-as-cash investments and pushing investors to buy more equities, the harder investors looked for high-yielding returns – whether from junk bonds, new types of investing such as government guaranteed infrastructure projects, or lumpy and illiquid investment sources such as aircraft leasing, green energy, or even artistic royalties.
The illiquidity risk (should have) persuaded investors to purchase these types of assets through closed-ended funds, rather than open-ended products such as unit trusts, and indeed this decade has seen a remarkable flowering of investment company issuance.
But the original buyers of this type of investment manager have another lesson to impart for today. They knew that regular income each year was what kept them rich, and income from bonds was surer than dividends and capital growth from shares. The Journal of Financial Economics study shows the same is true today.
The F&C philosophy
In the latter part of the 19th century, newly rich Europeans needed income in excess of that which was available from developed world bonds. What’s more, they also needed a growing income – whatever we believe now, inflation was a problem back then. The managers of the F&C trust, launched in 1868, came up with an answer that was then followed by their successors.
Their solution was as follows: buy the high-yielding bonds of emerging market economies (in those days the US, British empire countries such as Australia and India, or even South American republics), at a sensible valuation (such as 6-8 per cent at a time when gilts were selling at 3 per cent), check out long-term prospects, and diversify between countries and regions.
To this they added a focus on garnering income, then appended a little excitement with shares such as US railways. They were also sure to never forget the compounding effect of a growing income, and so never took risks of a capital loss.
Modern relevance
For those readers who cannot believe that such principles have any relevance today, a look at the portfolio and record of the Personal Assets Trust will persuade them otherwise. Investment is about portfolio design, based both on today’s and tomorrow’s circumstances, and the agreed objectives of managers and clients combined. The efficient market hypothesis may keep pension fund trustees entranced, but it wont make them rich.
