Monarchies make money

Since December 1999, the 10 developed stock markets that have had monarchical governments since the 1970s have risen by an average of 23.8 per cent in US dollar terms. The eight that have had republican governments have fallen by an average of 36.8 per cent.

Granted, this only reverses republican markets' outperformance in the 1980s and 90s; since December 1981, monarchical markets have done only 0.2 percentage points better than republican ones, rising by 8.7 against 8.5 per cent a year. However, during these years they have been less volatile than republican markets. This means that their risk-adjusted returns have been significantly better. Between December 1981 and April 2012, monarchical markets had an annualised Sharpe ratio of 0.368, which is 17.2 per cent better than republics' 0.314.

Yes, republics had the best-performing market during this time - the US. But they also had the worst-performer - Italy. Whereas only three of our eight republican markets have had an annualised Sharpe ratio of better than 0.3, half of our 10 monarchical markets can boast this (see table).

Now, you might argue here that there's a trivial reason for this - it just so happens that monarchical markets such as Norway, Canada and Australia have benefited recently from having strong exposure to resources stocks.

But this isn't the whole story. If natural resources were an easy road to riches, we'd be celebrating the economic miracles of Nigeria and Sierra Leone. We're not. Natural resources only enrich a country and stock market if political institutions are strong enough to prevent people fighting over them. In this sense, monarchies might have contributed to the success of resource-rich nations.

Monarchical versus Republican equity returns (£)

The past shapes the future

Certainly, economic research tells us that monarchies might affect stock markets. There's increasing evidence that even quite distant history affects economic behaviour today. Gregory Clark, professor of economic history at the University of California, Davis, has written: "Our very nature - our desires, our aspirations, our interactions - was shaped by past economic institutions, and it now in turn shapes modern economic systems." He has argued that the reason why England was the first country to have an industrial revolution - and thus became the world's richest nation in the 19th century - was that, since 1300, richer merchant folk had more children and this led to "an embedding of bourgeois values into the culture".

There are other examples of the importance of history. Here are just two.

■ Economists at Harvard University have found that countries that historically used plough-based agriculture tend to have lower fertility rates even in today's modern societies. This is because ploughs needed physical strength and so children made less useful workers, which in turn caused plough-based societies to have less of them - and this preference persists centuries later.

■ One reason why Greece has had large government borrowing is that the country's long history as a colony of the Ottoman Empire bequeathed a culture of distrust of government and hence legitimation of tax dodging.

Flame of the passions

Now, monarchies - by definition – have different histories from republics. It's quite reasonable to suppose that these histories have shaped our culture today. And this culture, in turn, can affect equity returns. Many people believe that stock markets are excessively sensitive to movements in investors' sentiment. Why shouldn't this sentiment be affected by a cultural legacy of monarchy?

But through what mechanism? I can think of two.

One is that republics create a more excitable temperament than monarchies. In 1651 Thomas Hobbes complained that parliamentary rhetoric was apt to incite the "flame of the passions" and to "excite men to action, but not govern them in it". Two centuries later, Alexis de Tocqueville - a greater admirer of democracy than Hobbes - said that democracy (which was synonymous with republican government in his time) "spreads throughout the body social a restless activity, a superabundant force, and energy never found elsewhere".

This difference between passionate republics and more buttoned-up monarchies persists in latter-day national stereotypes; it is the monarchical Englishmen who have stiff upper lips, while republican Italians and Frenchmen are passionate and excitable. And a glance at the hysterical culture wars that disfigure American politics vindicates Hobbes' view that republics arouse dangerous passions.

There's a clear link between this and stock markets. The greater volatility of republican temperaments generates greater stock market volatility – a tendency to overreact to good and bad news. Yes, the US has had low stock market volatility, thanks I suspect to its sheer size creating more diversification possibilities. But even the large French, German and Italian markets have had greater volatility than the Dutch or Australian markets.

Such volatility matters, because – contrary to basic economic theory – it is associated with lower returns. Across the 18 markets in our sample, the correlation between volatility and returns is minus 0.15. What's true of stocks – that defensive ones are undervalued and offer good returns – is true of whole markets.

Again, it's possible that the republican temperament is at work here. Republics are founded upon optimism; you don't overthrow monarchs or sail thousands of miles to a new land unless you tend to look on the bright side. Such optimism also leads people to pay too much for volatile assets, causing shares to be overpriced and so offer lower subsequent returns.

There's a second significant difference between monarchies and republics. Republican governments are constructed from first principles, whereas monarchical government has evolved. This means that republicans are more likely to believe in what Friedrich Hayek disparagingly called constructivist rationalism – the idea that a desirable social order can be built from abstract principles. Monarchists, by contrast, see an institution which makes little sense in theory but which works well in practice. They learn from this a scepticism about the power of rationality.

Profit as a by-product

Such scepticism serves us well in economics. John Kay explains why in his book Obliquity. The complexity of human affairs is so great, he says, that conscious planning cannot work, because it's too inflexible in the face of unforeseeable events. Instead, he says, our goals are best reached indirectly, obliquely: "The most profitable businesses are not the most profit-oriented. The wealthiest people are not those most assertive in the pursuit of wealth." He cites Sony's founding statement: "We shall eliminate any undue profit-seeking"; 65 years after that statement, Sony is, despite its travails, one of the world's largest companies.

The most successful companies, says Mr Kay, don't aim consciously at profits or growth. Instead, they focus on providing great products, and being stable organisations worth working for. The profits come as a by-product.

To get an idea of how obliquity beats rationalism, compare Handelsbanken, from monarchical Sweden, to the US's Citigroup. The latter was created by a merger in 1999 and its co-chief executive, Sandy Weill, said its goal was "increasing shareholder value". Handelsbanken has grown steadily since its founding in 1871 and has a decentralised corporate structure that favours stability over top-down growth. Since the start of 2008, Citigroup's share price has fallen over 80 per cent while Handelsbanken's has risen. Republican rationalism suffers catastrophically in crises; monarchical scepticism and trust in evolution survives.

Monarchies relative to Republics

Now, of course, not all companies in republics are as hubristically rationalistic as Citigroup and nor are all companies in monarchies as flexible as Handelsbanken. The disease of top-down managerialist rationalism has infected monarchies. It's just that sufficient scepticism remains in the latter to give them – on average – a slight edge.

Monarchies, then, are good for investors.

Or are they? On the day that Saddam Hussein was captured, Bloomberg News ran the headline: "US Treasuries rise: Hussein capture may not curb terrorism". Half an hour later, they ran another headline: "US Treasuries fall: Hussein capture boosts allure of risky assets".

This episode is an example of what Nassim Nicholas Taleb, author of the Black Swan, calls the narrative fallacy - our tendency to tell a story that connects possibly separate events. With a bit of imagination, any two facts can be connected.

Have I merely committed this fallacy? I honestly don't know. And even if I have, errors of logic are not always errors of fact.

ALSO SEE:

■ Jewels in the crown

■ The value of royal memorabilia

■ Managing a £400m portfolio

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