Last month I wrote about a number of people I know that are not putting money into a pension. Not only do these people not put money into a pension but they also tend to think that the stock market is too risky and that it is no different to gambling on a horse. They think I am mad to put most of my savings in the stock market. Many of them tend to have been burnt by investing in Eircom and this has left them scared of all shares. Even friends that do have some exposure to the stock market through employee schemes ownership schemes or through investing in a tip they have received from somebody else will express the view that the stock market is incredibly dangerous and not a place to put much money.
I then tend to give my little speech about the long term historical performance of equities. I tell them that history is on my side because in the long term a diversified portfolio of shares has always given a real return that justifies taking the risk. I do not tend to go into the detail and I certainly do not go down the road of giving an academic argument based on the equity risk premium. Now and again I might mention that I have met the executives of hundreds of companies and the vast majority of them attempt to generate profits greater than the risk free rate. I think that a number of people I have mentioned this to do not see the connection between the way the company is run and the share price. Everyone understands that Eircom was out to make a profit, sure isn’t Eircom robbing everyone blind! Yet this did not guarantee that people made a profit by investing in it. I cannot even argue that in the long run people will make their money back because they all got bought out at a loss. Even those people that still have their Vodafone shares will never make a decent return.
Having listened to so many people express the view that investing in the stock market is not for them has made me think long and hard about this idea of an equity risk premium. Is it really that easy? Can I genuinely say to people that all you have to do is buy an index fund or an index ETF (Exchange traded fund) and if you hold on to it for 10 to 20 years you will definitely do better than leaving the money on deposit? I realise that I cannot make the argument about any individual share because there are any number of reasons why one company will not perform. But can I genuinely make the argument that investing in a sufficiently diversified basket of shares that diversifies away stock specific risk will capture this magical thing known as the equity risk premium?
If it is genuinely that easy why isn’t everyone doing it? Surely every professional investor knows enough about history to know that equities outperform. Put your money into the market sit back and wait for the good times to roll. Just ignore those blips that are caused by inflation, oil, politics, terrorism, valuation bubbles, dodgy accounting, under funded pensions, strikes, greedy executives etc, etc.
Can I really say to people that the next time they hear George Lee on the RTE news say “billions wiped off the stock market”, they should just switch channels secure in the knowledge that the day billions are added to the stock market it will not make headlines on the RTE news.

Having had all these doubts and having asked all these questions about whether it really is that easy maybe I have hit the nail on the head because the reality is that nobody and I mean nobody I know finds it easy to ignore all the blips.
Lets look at it from a professional investor perspective. A few years into my investment career I remember one investment director made the case that equities outperform in the long run and therefore he decided to increase the exposure of long term funds like pension funds to equities. He gave presentations to clients supporting this position and then he sat back waiting for the good times to come along. Now of course he wasn’t to know that Iraq was just about to invade Kuwait. He wasn’t to know that the price of oil was going to increase dramatically. I don’t know if many people can remember back to that period and remember just how much fear there was of the Iraqi army. There was a genuine fear of a long lasting war that could destroy oil fields in Iraq, Kuwait, Saudi Arabia and possibly further down the Persian Gulf. The investment director still thought that in the long run equities would perform but he began to panic that on a one or two year view they would under           perform and in the world of professional investment you generally get fired if you under perform for three years. In the circumstances we panicked and reduced our exposure to equities. In hindsight it looked stupid because as we all know the Gulf war ended quickly and the price of oil fell back. Naturally enough a short while later the exposure to equities was increased again but the damage had been done.
Later on in my career another investment director made the same argument that shares were the place to be. After the stock market bubble collapsed in 2000 he began to have doubts. He held out until 2002. You can imagine my surprise when I came back from the world cup in Japan in June 2002 to discover that we had reduced our exposure to shares. The stock market hit bottom in 2003 and later on equity exposure was increased again.
I heard a similar story from a former colleague who worked in Swiss Re. They managed to sell at the very bottom in 2003.

Having seen how difficult it is for professional investors to ignore the blips makes me understand why it is that the equity risk premium appears to exist. If the professionals cannot take advantage of the long run what chance have the amateurs.

Only time will tell whether my analysis is right but it is my intention to invest through the blips and try to take advantage of this equity risk premium. I hope my clients will live with me through the ups and downs and we will all make money in the end. Watch this space.

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Killeevan Investment Consultants Ltd, trading as KIC, is regulated by the Central Bank as an Investment Intermediary.
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Directors: Kenneth Power (Managing) B.Comm, MBS, ASIP, Regular Member of the CFA Institute.
Siobhan Power