Standard Life Investments

Published Article

Citywire - Hysteria over FTSE highs belies its story on cashflow


“Can we break through 6930” the radio interviewer asked breathlessly. “After all, it’s been a 15 year wait for investors!” The next day the headlines were bold: ‘FTSE at new high!’

I sigh; one should never hold equities purely for capital returns. As study after study has shown – for example the Dimson, Marsh and Staunton year book - the bulk of returns comes from reinvested dividends. How much is £1000 worth if it had been invested in the FTSE100 index in December 1999? Answer £1600. If the FT All Share index had been chosen instead, the figure would be £1900. That is simply buy and hold, not market timing from tactical asset allocation. Indeed, in total return terms, the 1999 value was achieved again in 2005 and then again in 2009, so the bulk of the return was in the last five years.

All well and good; what about future returns? We regularly carry out a forecasting exercise for equities, bonds and real estate in the major economies. 10-year estimates can take account of such factors as entry and exit costs, as well as allowing compound interest to work its magic.

The important figure is 7% i.e. a central estimate of the possible compounded annual return from UK equities. In other words we consider – under certain key assumptions – that investing £1000 in the stock market in 2015 could be worth about £2000 by 2025. The three driving factors are dividends, dividend growth and risk.

First of all, the UK stock market has a dividend yield of about 3.5%, meaning it is paying out about £75 billion a year in dividends. Secondly, the ability to grow such cash looks to be about 3-4% a year even in the low growth world we expect for the foreseeable future. Risk is the key aspect to consider, of course. We have to make major assumptions about the type of world we expect over the coming decade. Investing over the 15 years 1999-2015 was complicated by two bear markets and 40% declines after the TMT and sub-prime mortgage crashes. Looking ahead, it is quite conceivable that imbalances will build and lead to another recession, but we assume that the new regulatory environment will limit the downside risks. The central figure of 7% could be rather higher if policymakers decide that much higher inflation is the best solution to the debt crisis, or conversely much lower if more of the global economy enters a Japan style deflation.

The FTSE can make new highs but remember that over time cashflow is more important than price.

Andrew Milligan, Head of Global Strategy, Standard Life Investments

First published in Citywire Wealth Manager – April 2015