Posted by Janette Rutterford on January 31, 2017
This week I went to the formal launch of the CSFI report on “Reaching the poor: the intractable nature of financial exclusion in the UK”. This highlights shocking figures on financial exclusion:
And yet, the financial sector makes billions out of providing financial products which are either beyond the reach of the poor or hugely more expensive than for the rich. Progress is painfully slow. How can this be speeded up?
Learning from the past
If we look at the history of savings and lending institutions, the role of the mutual, not for profit, local community organisation stands out. Yet the building society has almost completely disappeared, credit unions need less crippling regulation aswell as restructuring, and friendly societies are a tiny portion of the market. Many of these institutions, such as the Trustee Savings Bank and most building societies, were swallowed up in the boom years after deregulation. They need help to grow again.
Understanding modern day needs
The banking system is based on the premise that we get a job, earn a regular wage, start saving, borrow to buy a house, climb the promotion ladder, and then live out our retirement on a generous pension. It ignores the fact that most young people, by their early twenties, are heavily in debt. There is no longer a natural career progression – income can go down as well as up. And with zero hours contracts, it is almost impossible not to go overdrawn or max the credit card and incur huge penalties. A broken-down boiler can take you over the edge. What’s needed is a rainy day bank account which allows occasional overdrafts at fair, and not penal, rates.
Recognising the importance of regulation
Pay day loans are less of a problem now their rates have been capped. Banks have been forced, by the EU, to provide a free-of-charge bank account. Regulation works. It needs to go further, helping not-for-profit institutions and regulating those profit-making institutions which exploit the disadvantaged.
Turning the problem upside down
At the moment the poor pay more than the rich for less attractive products. Why should they? There are many ways to save which offer tax advantages, such as pensions. What if you don’t pay tax? Why should the rich get better savings deals than the poor? It is far cheaper to buy insurance if you can pay in a lump sum. What if you can only pay in instalments? Why should the poor subsidise the rich? That’s also happening with the state pension age going up. Life expectancy is linked to income. Why should the poor subsidise the rich? We’re a far cry from the 1970s and 80s when the rich paid income tax rates of up to 83% and a further 15% if the income was from savings or investment. Now, it’s the other way round.
Government should take the lead. It should ensure the provision of savings products which offer cash bonuses instead of tax relief to those who don’t pay tax. It should help those on low incomes to buy goods on fair terms. And it should encourage mutual and low-cost savings and credit institutions. The banks should be shamed into providing accessible and affordable financial products, not just for the rich but also for the poor. People have a right to financial inclusion. It’s time they were enfranchised.
Posted by Janette Rutterford on January 26, 2017
In my previous blog, I identified three ways to diversify globally – diversify by market size, naively, or use historical data to ‘optimise’ recognising that there’s no consensus on which historical data to use (one hundred years of history or the past five years, annual or daily data, real or nominal returns….?)
The problem is even greater than how to decide how much to invest in each country. There are two additional issues to address when diversifying globally.
First of all, should you have a currency view when you invest overseas? Many fund managers offer products hedged into sterling. Why? Surely the point is to diversify currency risk as well as equity risk? Or is currency a separate asset class? In that case, the investor hedges currency risk and runs a separate portfolio with just currency exposure. Unfortunately, there’s no academic agreement on which of these is the right approach. But individual investors typically take the currency risk of investing overseas – or even in the FTSE100 – without realising what exposure they are taking on. Many could not say whether their funds are hedged into sterling or not.
Second, when buying international funds, investors have a choice. They can buy funds which have a mixture of bonds and equities, or they can buy specialist equity or bond funds. Research shows that, of the three investment strategies I outlined above, the retail investor favourite is the naive approach – equal amounts in each fund. And, as GestaltU argues in his blog, since there are more equity funds than bond funds out there, and more equities than bonds in so-called balanced funds, the naive approach leads inexorably to a heavy equity bias. That may be a good solution for many investors, but it may not.
International investment is not for the faint of heart.
Posted by Janette Rutterford on January 24, 2017
Since the Brexit referendum and Donald Trump’s election as President of the United States, investors have woken up to the fact that it makes sense to reduce risk by investing in a range of overseas markets in a number of different currencies. . This is particularly true in the UK, where the FTSE100 index has done reasonably well post Brexit as most of the top 100 earn revenues in foreign currencies, whilst the more domestically oriented FT All Share index has done much worse.
Exchange Traded Funds (ETFs) now allow investors to create a global investment portfolio at relatively low cost. Just a few clicks and you can be tracking the S&P500, the Nikkei index, or an index representing non-UK European stock markets.
The dilemma the investor now faces is how much to put in each country. In other words, what asset allocation strategy to pursue? How much to put in the domestic market, how much overseas? Traditionally, investors preferred to put most of their money in their home stock market. Their brokers recommended shares listed on the local stock exchange (and there were provincial stock exchanges until the 1960s). They felt more comfortable buying shares in companies whose buildings they could see, like J. Lyons tea rooms, or whose products were advertised, like Liptons tea. But there is no such thing as a home market now. Famous British names, such as the Mini, are owned by foreign companies. Buying UK shares is effectively buying a set of international securities with varying amounts of exposure to different countries and currencies.
So the 64 trillion dollar question is: how much to put in each country? There are essentially three different ways to decide.
One is the Capital Asset Pricing Model (CAPM) approach, which says to buy what’s available. For example, North American stock markets account for 41% of global markets by value, Asian markets 33.3% and Europe 19.5% (including 4.7% for the London Stock Exchange). You can amend these numbers to make allowances for double counting or illiquidity, but the implication is clear. Put most of your money in the US, Europe and Asia, including less than 5% in the UK. There’s no local bias in this approach.
The second approach is what is called naïve diversification, which was the approach recommended for global portfolios pre-World War I, the first era of globalisation. This involves dividing the world into say ten different regions and putting an equal amount in each. In those days, there was no currency risk; you could buy sterling-denominated securities relating to countries around the world. Today, that’s no longer the case. And this strategy could mean putting 10% into each of Africa, Australasia and South America compared with their combined importance in world markets of less than 5%. And it definitely means putting no more than 10% in the UK. An even more challenging strategy?
The third, most popular way is to adopt a Portfolio Theory approach, but tinker with it. Portfolio Theory is a model which inputs historic returns, volatilities and correlations between markets, and comes out with the percentages to invest in each to get a good expected return for a minimum of risk. This is the approach which many of the robo investor sites are offering. Tell them your risk and return expectations and they’ll come up with an asset allocation strategy. This will have what appear to be random percentages in different markets, neither related to size nor evenly spread. Although you can’t see it, these are the outputs from the PT model based on the risk and return characteristics of each market. What you don’t know is how much the outputs have been tweaked to pander to local bias. You can guess that they have tweaked if the UK percentage is higher than 5 or 10%.
There is no perfect solution. But at least we know one thing. No longer are we expected to put most of our money into UK securities or funds. Now, we are expected to argue the other way. Why should I invest more than 5 or 10% of my portfolio in the UK? Global asset allocation has come to stay.
Posted by Janette Rutterford on January 20, 2017
Listen to a fascinating Radio 4 Money Box programme on an 1863 investment guide by a woman – Emma Sophia Galton – the sister of the eminent statistician Sir Francis Galton and, as her pseudonym reveals, the daughter of a banker. Her target audience was women, especially the unprotected single women with no man to manage their affairs. Her easy-to-read primer included advice on how to write a cheque, what to say to your broker when you wanted to buy shares, and how to diversify your investments. She also recommended taking advice from one man of business (not two) and never to marry without a prenuptial agreement or ‘marriage settlement’. Miss Galton lived to the ripe old age of 94, presumably living on her royalties, as the final edition came out in 1901.
Posted by Janette Rutterford on January 17, 2017
Chris refereed my first finance history article and encouraged me to work in the area. He was a gentle giant.
I’ve just learned that the distinguished business historian Chris Kobrak has died. I’ve known Chris from conferences for a number of years and over the course of the last eighteen months I got to know him quite well. I deeply respected Chris as a human being and a scholar and proximity to him caused me to be a better person by being more international, more financially literate, more generous with money, and to pay more attention to ethics. When I say pay attention to ethics, I do not mean to suggest that I was unethical before I met Chris. Rather, I mean that I am more conscious of ethical issues when engaged in writing and thinking about business history and in thinking university teaching and life more generally.
To understand why Chris was an important figure in the global business history community, we need to consider his family background and career…
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Posted by Janette Rutterford on January 11, 2017
We live in a volatile world. And the stock market is no exception. Shares have lost a third to a half of their value in the past two years and some share prices are down to levels not seen since the mid to late 1990s. Many of us are feeling the pain.
But we shouldn’t feel too sorry for ourselves. Investors in the past lived in a much more uncertain and less transparent world. There were few financial institutions such as pension funds and unit and investment trusts which did the investing for them. Investors had to make their own investment decisions and these decisions were much more important as many people –so-called rentiers – lived on the income from their investments. They did not have good pension plans on which to depend for their old age. And the amount of income they received from their investments dictated how many servants and carriages they had and hence their social status. If they lost money on the stock market, and lived in ‘reduced circumstances’, their previous ‘friends’ stopped visiting them. Social class was determined by income. This comes out clearly in the novels of the nineteenth century – for example, Miss Matty in Mrs Gaskell’s Cranford and Mrs Bates in Jane Austen’s Emma.
Women had a particularly raw deal. From the 1850s onwards, there was a surplus of single women, which can be explained by primogeniture amongst the wealthier landed gentry – that is, the eldest sons got everything, the younger sons couldn’t afford to marry, and the daughters did not have a large enough dowry to attract a suitor. Too high class to work, these daughters depended on their investment income, especially after their parents had died, for a respectable lifestyle. And there were lots of them. Trollope novels are full of them – Lord George Germain had four unmarried sisters in Is He Popenjoy? And Sir Marmaduke Rowley had no less than eight unmarried daughters in He Knew He Was Right. And widows also took investment risks to ensure their children could go to the right schools and mix with the right social classes. And the problem got worse by the end of the nineteenth and early twentieth centuries when the yield on risk free government bonds fell to below three per cent.
The limited liability companies acts of the 1850s and 60s opened the floodgates to a wave of company flotations but also to a wave of booms and busts – for example, the crash triggered by the collapse of the bank Overend Gurney in 1869 – the basis of the story of Anthony Trollope’s famous novel, The Way we live now. The Baring crisis of 1890 also caused ructions and railway shares, an early nineteenth century favourite, had a major boom and crash in the 1840s, referred to in novels by both Charles Dickens and Wilkie Collins.
Investors, especially widows, spinsters and clergymen, were suckers for beautiful company prospectuses which promised high returns and no risks, such as the Burma Ruby Mines prospectus, issued in 1889, which, as well as providing beautiful maps of a faraway country, reassured readers that ‘having the sole control of the only known mines in the world producing these very valuable rubies, it is expected that the company will be able to regulate the product so that a good price for the stones can be steadily maintained’. The shares certainly promised higher returns than the measly 2 or 3% then available on government bonds. Despite the fact that most investors never left British shores, many – especially before World War I – spread their risk across the globe, happy to invest in companies operating in India, Canada and Australia or in Argentinian, Chinese or Russian railway bonds. The world was on the gold standard and a sterling cheque was honoured almost everywhere. They thought the world was their oyster and I still have the – worthless – share certificates of my great uncle whose particular preference was for Central African mining company shares.
Even when companies with a track record were floated, investors received limited financial information and were reliant on articles in newspapers whose editors could be bribed by unscrupulous promoters to “puff” or promote certain dubious concerns. Investors tended to take much on trust and felt happiest when they received regular directors and the directors on the board were titled and the Chairman, preferably a Lord, gave a good speech at the annual general meeting. And annual general meetings were very popular – in some cases so popular that the police had to be employed for crowd control. Cecil Rhodes, after whom Rhodesia was named, was a director of the British South Africa Company. At a 1901 meeting, thousands of shareholders were unable to get into the meeting room at the Cannon Street Hotel – which already held 2,000. There was a cry from the cheering crowd outside that only the Royal Albert Hall would do! But not all directors knew as much about business as Cecil Rhodes. The Marquis of Dufferin and Ava had previously been Viceroy of India and Governor-General of Canada before taking up the post of Chairman of London and Globe Corporation in 1899. At the annual general meeting, he confessed to distress at the failure of the company. A small shareholder, Arnold White, stood up and said that he had invested ‘entirely on the strength of the Chairman’s name’ and his confidence in the Chairman ‘had been increased by the noble, manly and touching address to which that meeting had listened’. He went on to ask that, as the Chairman ‘had in the frankest and manliest way admitted his ignorance of the particular business which had brought about the company’s misfortunes’ he should consider adding someone to the Board who might know something of the affairs of the company. Three cheers for the Chairman and three more for Lady Dufferin terminated the proceedings.
At these meetings, both women and men were not afraid to question management, taking a lively interest especially when investing in retail stores and restaurants. At the J. Lyons meeting, they made suggestions as to menus and where to locate the cafes, and also enquired about waitresses’ pay. They wrote to the chairman of the Prudential Assurance Company asking for higher dividends and also making suggestions as to how to manage the insurance business. They asked after overcrowding in Indian trains and about employee share schemes in mining companies. There is a long and honourable tradition of shareholder criticism which we see today at meetings of partly nationalised banks Lloyds and Royal Bank of Scotland. Not all shareholders were active, some happy just to cash the dividend cheques. But enough shareholders took a lively interest in what was to them their passport to an adequate income and a decent old age.
Posted by Janette Rutterford on September 20, 2009