Should we be thinking about our investments in a different way – the way Jane Austen did?
These days we tend to assess our net worth by the market value of our assets. This has not always been the case. In the 19th century, wealth was measured by the size and reliability of a person’s income.
As Miss Crawford said in Jane Austen’s Mansfield Park (1814), ‘A large income is the best recipe for happiness I ever heard of.’ The economic situation today has some striking parallels with the 19th century, where liberalisation led to pricing pressures and deflation. Interest rates and government bond yields in 1825 were at similar levels to those of today.
The catalyst this time round was the aftermath of the dot-com crash in the early part of the century. Interest rates and stock prices plunged, creating a perfect storm for pension funds. The value of their liabilities rose and the value of assets owned to meet them fell, pushing a number of companies in weak industries such as airlines and steel into bankruptcy.
In response, many corporates, particularly in the UK and US, shifted away from defined benefit pensions, which provide a guaranteed income stream towards defined contribution plans. In the Harvard Business Review, Nobel Prize-winning economist Robert C Merton argued that the shift in approach is storing up the seeds of a savings crisis down the line.
If pensions are invested to maximise capital value at the time of retirement but the goal of most savers is to achieve a reasonable level of retirement income, this creates a mismatch that almost guarantees that savings are badly managed. Why is this? The main reason is that an investment that is risk-free from an asset value standpoint – for example, Treasury bills – may be very risky in income terms.
Merton’s assessment concluded: ‘Our approach to saving is all wrong: we need to think about monthly income, not net worth.’ This shift has implications for how we save and invest. If our priority becomes the long-term, inflation-adjusted purchasing power of our money, then we start to view risk and outcomes in a different way. T-bills, bank deposits and other near-cash investments are no longer the lowest-risk assets we can own.
A ‘smarter’ approach to structuring portfolios to ‘future-proof’ an income stream calls for different kinds of portfolios. Financier Mohamed El-Erian agrees that traditional diversified asset allocations can no longer be counted on in the way we have in the past, and that savers are the innocent victims of central banks’ policies.
In a Wharton interview he said: ‘The first thing investors have to realise is that we’ve already borrowed returns from the future.’
El-Erian argues you need to evaluate your investments with the following criteria in mind: resilience, agility and optionality. What does this mean in practice? Bonds and money market instruments cannot deliver security in terms of income.
In fact, given their low expected real return, they look very unappealing, other than as a war chest. In contrast, equities when viewed in this new light are not necessarily significantly riskier as long as they generate and distribute earning streams over the long term.
As we enter what many are calling the ‘hard part’ of the recovery in a world experiencing the worst recession for 300 years, companies and countries are being forced to relearn some basic lessons and to examine how prepared they were for the worst. For most, the answer has been that they were not prepared and weaknesses in supply chains and businesses models have been exposed.
David Bailin, global CIO of Citi Private Bank, points out that true diversification can only be achieved with assets that are not correlated with each other but still have the potential to grow. Cash, he reminds us, is of no benefit because it has a zero return potential.
Chinese equities, on the other hand, are an example of assets that combine the potential of a good investment outcome, benefiting from increasingly domestically driven growth, with significant opportunities for risk reduction, as they have displayed very low levels of correlation with most asset classes over the past ten years.
It seems to me that we would all be well advised to reconsider how to achieve true diversification in our portfolios with this new lens. I recommend ensuring that you demand some form of yield from your assets, while maintaining a sharp focus on where the new global centre of gravity is moving to.
Regarding your wealth as a reservoir for long-term future consumption, and making decisions about your investments based on the level of trust you have in them and their ability to continue to deliver on their promises, could be a good way to achieve this.
I will leave the last word to Mansfield Park’s Henry Crawford: ‘How to turn a good income into a better’ is ‘the most interesting [topic] in the world.’
Annamaria Koerling is managing partner of Delfin Private Office
Image: Colorized version of engraved depiction of Jane Austen, 1873