Ever wondered what the secrets are to a really successful investment strategy? "Confused" of Island Bay, Wellington writes "for the last five years I have followed a strategy of positive thinking, power dressing and saving $3.70 a day by skipping my morning coffee but, inexplicably, I am still not on the Rich List. What am I doing wrong?"
Confused speaks for many when he asks what investment strategy will work. Some people look to the rich and famous for an insight into what works, with Warren Buffett being the most visible mega investor.
So what do the mega-rich do that is different to mum and dad retired and living in Herne Bay? Is the key to achieving millionaire status really as some local, non-millionaire, experts suggest simply down to positive thinking, power dressing and saving a few dollars here and there by giving up essentials like coffee and alcohol?
Well aspiring rich-listers, wonder no longer, a new study by Robert Arnott, Peter Bernstein and Lillian Wu sheds some light on how the mega-rich get mega-rich. The bad news is that a strategy of buying hedge funds, venture capital, and heaven forbid, preferential access to IPO's doesn't guarantee success any more than does positive thinking or hiring a fashion consultant and what is worse the mega-rich frequently don't stay mega-rich for long.
The authors make the point that "the hyper wealthy, in our experience, can outperform mainly by avoiding the fad chasing behaviour of the masses, rather than seeking lofty returns from unconventional methods. Those who believe otherwise generally fall prey to knaves and do not remain hyper wealthy for long".
The Arnott, Bernstein, Wu (ABW) paper is entitled "The Rich Get Poorer: The Myth of Dynastic Wealth" and its primary objective was to correct a few errors in economist, Thomas Piketty's best seller Capital in the 21st Century. Piketty's book caused a huge stir because it argued, correctly, that inequality is increasing in the world and the rich are getting richer.
Billionaire Warren Buffett. Photo / AFP
The ABW study doesn't challenge that idea - it is pretty obvious that inequality has increased with the most obvious anecdotal evidence being the obscene bonuses accruing to executives in the finance sector - but it does argue that inequality will not get worse, at least for the reasons outlined by Piketty.
What makes the ABW study interesting to retail investors and hopefully Herald readers however is where the authors look at the investment performance of the world's richest people on the Forbes 400 list, an annual listing of the world's wealthiest people.
In his book Piketty looks at the Forbes 400 data and notes that the share of billionaires private wealth has increased almost four fold from 1987 to 2012. The ABW paper points out that whilst Piketty assumes it is the same people getting richer nothing could be further from the truth.
By analysing the list, the ABW paper argues that inclusion in the list is almost always due to invention, innovation or entrepreneurial risk bearing. That's how Buffett, Gates and before them Getty, Ford and Rockefeller achieved their wealth. They are by definition "one in a million" and that sort of talent can't be easily replicated.
The authors add that "Idlers, even if in the past they were hard working competent people do not linger long on the list. Their wealth dissipates into society. If dynastic wealth accumulation actually occurred we could expect little change in the composition of the list. Instead there is huge turnover with less than 10 per cent of the names on the 1982 list remaining on the 2014 list".
The authors make the point that wealth accumulation today is usually more about entrepreneurial activity that also builds wealth for society - think Steve Jobs for example. The transitory nature of individuals on the list is illustrated by the Rockefellers and the DuPonts. In 1982 there were thirteen Rockefellers on the list and twenty five DuPonts. As of 2014 only one Rockefeller remains and the DuPont name exited in 1999.
The authors estimate that the average real return enjoyed by the 69 families who were on the 1982 Forbes 400 list and the 2014 list averages 6.5 per cent pa. For comparison a 60/40 equity/bond portfolio returned 10.2 per cent real over the same 32 year period.
So if it's not worth looking at the investment strategies of the rich and famous for inspiration where should we look for investment gems? Perhaps not the NZ Minister of Finance if one of his latest speeches is any indication.
The authors conclude that far from outperforming the rich and famous frequently invest less successfully than retail investors could by just investing in index funds and they make the point that "today's wealthy pay a nice chunk of change to bank trust companies, wealth management experts, estate attorneys and the like - a lot of fingers are constantly dipping into the wealth pie".
So if it's not worth looking at the investment strategies of the rich and famous for inspiration where should we look for investment gems? Perhaps not the NZ Minister of Finance if one of his latest speeches is any indication.
It seems like one of the perverse side effects of political life is that when a highly educated, sensible person chooses a career in politics they inevitably renounce their training and begin making ridiculous statements. The Hon Bill English has a Commerce Degree from Otago University, worked at the Treasury and, as well as being the Minister of Finance, is the Deputy Prime Minister.
Despite these credentials when he delivered the keynote address at the 2015 INFINZ Awards he apparently said "that the privatised power companies, Meridian, Genesis and Mighty River, had delivered the government as a 51 per cent shareholder post-float, twice the dividends it had received in the best pre-float year as a 100 per cent shareholder. This was, he said, "a measure of the benefits of the scrutiny that you apply to these companies".
English appeared to be attributing some of the ostensibly better performance of the power companies to the fact that they were now listed on the stockmarket. Hmmm, how that would happen so quickly isn't immediately obvious.
Let's think about it. Dividends from companies are a function of two variables; firstly how much operating cashflow a company produces and secondly how much of that cashflow the company chooses to distribute. The increased dividends from the privatised power companies arose chiefly because the directors of the companies increased their payout ratios.
For example in a recent presentation Mighty River executives showed that the payout ratio of Mighty River had increased from 40 per cent of free cashflow in 2011 to just under 90 per cent cashflow forecast for 2015. It had nothing at all to do with increased scrutiny, whatever that is.
It's ironic that senior members of the government would behave like this and at the same time be urging the public to upskill in investment matters.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.
