On any given trading day on the stock market, the risk of loss is not far from 50% – investors might as well be tossing a coin. Extending the investment horizon out to a week, or a month and we can see that the prospect of a loss from UK equities reduces slightly, but is still rather substantial. This is why having a short-term investment horizon makes equities a riskier investment proposition – in the near term, volatility matters.
We have consistently said that investing in equities requires a minimum time horizon of three-to-five years but, realistically, the longer the better. On a 10-year view, for instance, the probability of loss is negligible while the potential returns are significant for those willing to tolerate the volatility. Time is on your side when you take a long-term view.
Many investors also appear to be concerned about the timing of the new fund launch, given the elevated level of equity markets at present. We have recently explored the long-term returns that can be delivered by the equity asset class, which will hopefully assuage some of these concerns. However, we believe it is also important to look at the attraction of UK equities relative to other asset classes.
The simplest way to do this is to focus on a critical part of any investment’s total return – its yield. Traditionally, investors haven’t had to look much further than the banks or building societies for a decent income stream through deposit interest. Those days are over, however, possibly for several years to come. Meanwhile, Gilts (or sovereign bonds more generally) have been another favoured asset class for income investors, but here too, yields have been steadily decreasing for years and, since the financial crisis, have contracted still further, even turning negative in some countries. Yes, that means that investors are effectively paying for the privilege of lending money to their governments!
The ‘go-to’ asset class
For most of modern history, these other asset classes have been the primary domain of income investors because of the attractive yields they were able to offer. Equities, meanwhile, have tended to have a much lower yield, relying on dividend growth for a greater part of their superior return. In recent years, however, all of that has been turned on its head. The equity market has become, in our view, the go-to asset class for income investors.
As the chart below illustrates, at the end of February 2017, the yield you would have received from UK equities was 3.9% compared to 1.1% from Gilts and a mere 0.25% from depositing cash. From an income perspective, UK equities clearly look the most attractive, especially when you take into account that, at current valuations, holding Gilts to maturity will undoubtedly lead to a permanent loss of capital and, with interest rates likely to remain ultra-low, any return on cash deposits will remain negligible.