The patient investor

Those outside the investment world often assume equity fund managers’ attitudes remain consistent, and that professional investors search for the perfect stock and build a portfolio of similar companies. And indeed, the past 25 years have been characterised by the widespread availability of easy borrowing.

The credit boom has driven up the prices of assets – not just houses, but equities, bonds and commodities. Fund managers have struggled to keep fund returns ahead of rising indices. During credit booms it has proven advantageous to overweight portfolio balance towards riskier higher beta stocks. It paid to take on extra volatility during the market rallies.

While that assumption about investment strategy has been valid for a long period, just occasionally there can be remarkably significant changes.

During the credit crisis, for example, many fund managers naturally favoured companies with the safest balance sheets. Those with robust cash balances saw their share prices outperform those with large and potentially dangerous debts. However after UK interest rates were cut from 5.75% to 0.5% and the government embraced quantitative easing (QE), market trends changed. Companies facing the danger of receivership found they were able to get support for rights issues, after which their share prices actually rose because the insolvency risk had been largely eliminated.

Those fund managers who didn’t change their attitudes quickly found they lost out in terms of performance. This behaviour persisted for perhaps a few quarters. However, I see a major long-term change of fund management preference coming through – one I believe will persist for the next few decades.

In the past, credit booms haven’t lasted long. Inflationary pressures often forced up interest rates, preventing overextended leverage continuing. But this recent credit boom has been different for two principal reasons: it has been global in its reach and it has persisted for more than two decades. The investment culture has come to be dominated by the speculative. The changed make-up of the FTSE 100 Index demonstrates this. In the 1980s, UK businesses like ICI and GEC were dominant. Now many of the more recent additions are resource businesses often with operations in developing markets.

Capital growth or yield?

The present credit boom has been with us for so long that investors have come to treat it as normal. Effectively, fund management preferences have been aligned with credit boom conditions. Many fund houses focus on maximising the capital value of their portfolios. Most are benchmark aware, seeking to add value relative to the universe of stocks within an index.

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