"Bonds may be safe but they're boring. Shares are risky but they're a great long-term buy-and-hold investment". The statement above sums up the prevailing consensus among most financial professionals for the past few decades. Off the back of this, a huge industry has emerged which channels hundreds of millions of pounds every week into regular savings plans, charging along the way a dazzling array of fees at almost every stage of the food chain.
The only niggling problem is that the evidence for the bold assertions that underpin the industry's claims are under attack. The Cult of Equity, as it's called by its critics, is being constantly challenged by researchers, analysts and commentators using simple returns data, which suggest that over the past few decades shares (in aggregate) have been a poor investment.
One of the most articulate critics is US commentator John Mauldin, whose weekly missives can be found at www.investorsinsight.com. "Buy-and-hold investing is something that was basically foisted on investors by an industry that wanted to keep assets under management," he says. "If you're a long only manager and that's your hammer, then all the world looks like a nail, says Mr Mauldin. "You're not going to stand up and say: 'You know, I don't think it's a good time to invest in my fund. I think we'll just shut it down.' You'll be fired."
Mr Mauldin suggests that equities are in fact very risky, so risky that they're too dangerous for most investors with their short-term horizons. His major statistical evidence comes from US analyst and researcher Rob Arnott. In a paper entitled 'Bonds: Why Bother' for the Journal of Indexes a few months back, Mr Arnott laid out a clear case for the prosecution. "Most observers, whether bond sceptics or advocates, would be shocked to learn that the 40-year excess return for stocks, relative to holding and rolling ordinary 20-year Treasury bonds, is not even zero." According to Mr Arnott, real returns for capitalisation-weighted US indexes, such as the S&P 500 index, are now negative over any span starting 1997 or later. In Mr Arnott's view, investors "underestimate the carnage" from equities.
The evidence is in the graph below. From 1802 to February 2009, the line (which represents the extra return from equities versus bonds) rises nearly 150-fold. "This doesn't mean that the stock investor profited 150-fold over the past 200 years," says Mr Arnott. "Stocks actually did far better than that, returning four million times the initial investment in 207 years. Bonds returned 27,000 times our money over the same span." So, on paper at least, over the very long term equities appear to have won the battle – giving investors a 2.5 per cent advantage each year. According to Mr Arnott, that 2.5 percentage point difference in returns had two sources: "Inflation averaging 1.5 per cent trimmed the real returns available on bonds, while real earnings and dividend growth averaging 1 per cent boosted the real returns on stocks."
But look closely again at the graph above and start with the 1960s this time rather than the century before last – over the past 40 to 50 years you will notice that the relative outperformance of equities, that remorseless rise of risky assets, has vanished. Equities have failed to outperform bonds for decades.
