I recently had the pleasure of listening to a lecture by Professor Elroy Dimson from the Cambridge Judge Business School. As he talked us through the long-term history of equity markets, it struck me how much we can learn from looking backwards.
My first lesson was how much things change. In the 1900s, bonds were the main asset class, soon to be overtaken by equity markets in what Dimson termed the "triumph of the optimists". Those investors that believed in companies offering a share of their profits were rewarded handsomely. And that's what equity holders, and most long-term charity investors, rely on today. In 1900 the UK was the biggest equity market in the world. In the 1980s Japan made up half of the global equity market. Now the US represents almost 60 per cent of global equity markets: US-listed firms are bigger than the rest of the world's listed companies put together. Whole industries that were hugely significant, such as the railways, now form a much smaller component of markets. Likewise, industries such as technology did not exist in the 1900s, but are cornerstones of today's investment markets.
The second lesson concerned "stranded assets". In my investment lifetime this term has been used to describe oil reserves owned by large oil companies that, because of global warming, might not be burnt and might therefore be valueless. Dimson drew parallels with the canals: fundamental to the transport of goods until railways were invented. Canals were still used, but their importance was significantly diminished: they were stranded assets. Same idea, different century.
Third, it was interesting to reflect on how the past has shaped today's portfolios. Modern portfolio theory talks of diversification: not putting all your eggs in the equity basket. This was developed in the 1950s, when equity investors had only just recovered the value lost in the 1920s, when the equity market fell by 75 per cent. It took two decades to recoup the real value of assets invested in that period.
For charity investors with long-term time horizons, these lessons from the past illuminate today's investment strategies. Portfolios should be designed to cope with changing environments, so passively investing the most money in the largest companies of today might not be the best for returns. Instead, we should be looking for the companies of tomorrow and appraising the prospects for industries with stranded assets. This doesn't necessarily mean not owning resources companies, but making sure the price you pay for them reflects the challenges they are likely to face. And diversifying our charity portfolios makes sense, because times can be tricky. Here's hoping we won't need the insurance.
Kate Rogers is head of policy at Cazenove Charities