Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 66

Elroy Dimson on investing, expectations and truth in numbers

Elroy Dimson is a Finance Professor at Cambridge University, Professor Emeritus at the London Business School, Chairman of the FTSE Advisory Board and Chairman of the Strategy Council of the Norwegian Government Pension Fund. With his co-authors, he is the world’s leading authority on the history of financial markets. His Global Investment Returns Yearbook, produced annually with Paul Marsh and Mike Staunton, gathers data across major asset classes for 25 countries (including Australia) over 114 years, and is often quoted as the definitive source of market information.

I met Elroy Dimson at the 2014 Research Affiliates Advisory Panel at Laguna Beach, California.

When Elroy Dimson presents a paper or consults to clients in New York, he tries to be back home in London the same or the next day, often without needing a hotel room. Some of his meetings with the Norwegian Pension Fund are held at Heathrow or Oslo Airport. He is acutely aware that his highest profile work, the Yearbook, is taking up more of his time each year. Dimson is one of those people who needs 25 hours in every day.

Real return expectations

The obvious question for someone who analyses thousands of data points across 25 countries each year is what should an investor learn from reading the Yearbook. For example, it reports that US equities have never delivered negative real returns in any 20 year period. Does this mean a long term investor with a 30 to 40 year horizon should be invested almost all in equities?

Dimson does not encourage this view. He agrees that if you look at the statistics since 1900, the minimum holding period to be confident of a non-negative real return for US equities is 17 years. But the average for European countries is between 40 and 50 years, and he advises not to extrapolate from the past US experience, as the US may not be superior to most other countries in the future. Looking forward, with real bond rates around zero and an equity risk premium of maybe 3 to 3.5% and a 60/40 asset allocation, the overall return will be 2% real before fees. This is well under the expectations of most people.

He says expectations of returns have come down, and now many ‘thinking people’ believe a 3 to 4% real return is a more sustainable level for equities. By ‘thinking people’ he means consultants and asset managers who are honest with their clients, not worried that the client will think the consultant is failing to help achieve return objectives. Or that the next consultant or manager pitching 30 minutes later will be more optimistic and win the business.

Most investors need to accept and manage with these lower returns. Some endowments are supported by gifts, so maybe it matters less for a higher education institution or a charity funded by a flag day, but others who have to exist on what they earn need to manage it very carefully.

Asset allocation and rebalancing

Dimson has strong views on so-called tactical asset allocation. He says there is no evidence that market timing works. But he is in favour of countercyclical investing, in other words, buying when the mass of investors need to sell. When equity markets have declined, for example, insurance companies are faced with solvency margin implications, which means they can't do their ordinary insurance business. If they don't have the right balance sheet, they are forced to sell their risky assets. It makes sense for longer term, long horizon, low liability funds to move in the other direction.

The most difficult part of a rebalancing, such as buying stocks when markets are still falling, is going against what most others are doing. Dimson says it's very important when buying on weakness and selling on strength to have a long term strategy that stops knee-jerking. He quotes a British insurance company which during a heavy market fall announced a strategy of buying cheap. They were loading up on equities as prices fell, but then had to reverse their actions to maintain their solvency margin. Likewise, family offices, institutional investors or sovereign wealth funds must be able to maintain the strategy, because the worst of all is to knee-jerk and end up in a big mess. The Norwegians don't fall into that trap because they have a disciplined approach to strategy.

The truth in the numbers

Dimson is most often referenced for his long term data work, but the Yearbook has become more than simply an accurate source of financial markets numbers:

“Occasionally we do venture into expressing strong opinions, but quite often, we try to let the data speak for itself. We don't make such strong statements as people who make a living from forecasting. Most frequently, we are listening to what we think are current concerns. We have to form a judgement by about September each year on what will be the hottest issue in February the following year, and then we do the research. We try to capture what many people believe, and we can then let the data confirm or reject the story.

“When it became clear that expected returns were lower, we wrote extensively about that. We also analysed historical data to see if equities might save you from low interest rates. History reveals that income oriented equity strategies have had a long-term total return that has been superior to growth oriented strategies. There, we were a bit more forceful.

“Some market beliefs are not well-founded. The work we did earlier this year on emerging markets addressed the belief that emerging markets outperform, but there’s no compelling evidence one way or the other. Some investors who follow our work closely have ended up having much the same percentage in emerging markets, Europe, North America, and the rest of the world.

“We’ve also looked at country rotation strategies. People have said if you’re invested internationally, you should avoid countries with weak currencies. You don’t want gains on a national stock market to be offset by weak currencies. But we find you get a higher long-term reward from the equity markets of countries that have experienced prior currency weakness.

“Some believed if you buy countries with strong economic growth, you’d be rewarded. We thought this was implausible, and our evidence is clear. If you buy the common stocks of countries that have low economic growth, the subsequent performance is on average better. The extra risk is rewarded.”

Financial markets commonly feed on urban myths and generalisations, but Dimson finds truth in the numbers. He likes nothing more than testing a market perception that has gained credibility, using long-term data to evaluate it – and quite often, to shoot it down. And then he’s off to track down someone who has the data on the 26th country to add to the investment return series, or to tweak the accuracy of last year’s numbers. It’s a project which will never end.

RELATED ARTICLES

How inflation impacts different types of investments

Lessons from 32 years of investment returns

banner

Most viewed in recent weeks

Stop treating the family home as a retirement sacred cow

The way home ownership relates to retirement income is rated a 'D', as in Distortion, Decumulation and Denial. For many, their home is their largest asset but it's least likely to be used for retirement income.

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

Latest Updates

Investment strategies

Charlie Munger and stock picks at the Sohn Conference

The Sohn Australia Conference brings together leading fund managers to chose their highest conviction stock in a 10-minute pitch. Here are their 2021 selections with Charlie Munger's wisdom as the star feature.

Interviews

John Woods on diversification using asset allocation

All fund managers now claim to take ESG factors into account, but a multi-asset ethical fund will look quite different from a mainstream fund. Faced with low fixed income returns, alternatives have a bigger role.

SMSF strategies

Don't believe the SMSF statistics on investment allocation

The ATO's data on SMSF asset allocation is as much as 27 months out-of-date and categories such as cash and global investments are reported incorrectly. We should question the motives of some who quote the numbers.

Investment strategies

Highlights of reader tips for young investors

In this second part on the reader responses with advice to younger people, we have selected a dozen highlights, but there are so many quality contributions that a full list of comments is also attached.

Investment strategies

Four climate themes offer investors the next big thing

Climate-related companies will experience exponential growth driven by consumer demand and government action. Investors who identify the right companies will benefit from four themes which will last decades.

Investment strategies

Inflation remains transitory due to strong long-term trends

There is momentum to stop calling inflation 'transitory' but this overlooks deep-seated trends. A longer-term view will see companies like ARB, Reece, Macquarie Telecom and CSL more valuable in a decade.

Infrastructure

Infrastructure and the road to recovery

Infrastructure assets experienced varying fortunes during the pandemic, from less travel at airports to strong activity in communications. On the road to recovery, what role does infrastructure play in a portfolio?

Economy

The three prices that everyone should worry about

Among the myriad of numbers that bombard us every day, three prices matter greatly to the world economy. Recent changes in these prices help to understand the potential for a global recovery and interest rates.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.