Cracks me up but hasn't gained much traction in the academy.*
From The Economist's Buttonwood blog:
THE annual report on markets by Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School (produced in association with Credit Suisse) is always good value and this year's effort is no exception. The main theme is related to emerging markets and will be the focus of this week's column. But one oddity emerged in the course of the report that it is quite difficult to explain and is worth exploring in more detail.Here's the CS publications page for a free download of the Yearbook.
An oft-quoted argument for investing in emerging markets is their superior economic growth. But the professors have pointed out in the past that economic growth and equity returns are not correlated at all. Jay Ritter of the University of Florida has a paper on the same issue. If this lack of relationship seems odd, the professors' argument is more subtle; yes, it would be useful to be aware of future economic growth. But being aware of past economic growth does not help; or rather, it is a a contrary indicator. You would be best placed investing in the slower-growing economies of the past, not in the fastest.
This may well be a value effect; stocks in fast-growing economies get bid up in price (price-earnings ratios go up and dividend yields go down) while the opposite occurs in the slow growers. Indeed, buying the emerging markets with the highest dividend yields returned 31% a year, compared with 10% a year for low-yielding markets. (A shame this hedge fund didn't spot this simple rule.) It would help investors to know which economies will grow fastest in the future but of course investors don't know this; the academics have a wonderful scatter chart showing the lack of correlation between growth rates in one year and the year after next.
But now for the puzzle. Over the long run (1900-2013), there is actually a negative correlation (-0.29) between real equity returns and per capita GDP growth; South Africa, for example, has had long-term equity returns of 7.4% and per capita GDP growth of 1.1%; Ireland has had per capita growth of 2.8% and real equity returns of just 4.1%. But there is a positive correlation between aggregate real GDP growth and real equity returns (0.51).
Why the big difference? Of course, the gap between aggregate and per capita growth is explained by population movements. South Africa's aggregate GDP has grown faster than Ireland's but more than half of this is accounted for by a bigger population; Ireland's population has risen very slowly thanks to periods of emigration so almost all its economic growth is per capita. The professors use the analogy of equity issuance; as countries grow their stockmarkets get bigger as more companies float and more shares are issued. In theory, profits might double but if share issuance doubles, investors will be no better off....MORE
*From Prof Dimson's personal homepage:
Professor Elroy Dimson is Leverhulme Emeritus Fellow at London Business School, Fellow and Visiting Professor at Cambridge Judge Business School, and Chairman of the Strategy Council for the Norwegian Government Pension Fund.Among our posts on/by the good Professor:
He has served London Business School as Professor of Finance, Faculty Governor, Chair of the Finance and of the Accounting areas, Dean of MBA Programmes, and Director of the Initiative on Foundation and Endowment Asset Management.
He has been an Associate Editor of the Journal of Finance, Review of Finance and other journals, and is co-author of Triumph of the Optimists and the Global Investment Returns Yearbook 2013 with Paul Marsh and Mike Staunton; and of Endowment Asset Management with Shanta Acharya.
Elroy is Director and Past-President of the European Finance Association, and is a member of the advisory boards of the CFA Institute, FTSE Group, and Russell Investments. He sits on the investment committees of Guy’s and St Thomas’ Charity, UnLtd [the Foundation for Social Entrepreneurs], and the University of London endowment.
Elroy’s research, writing and consulting blends the themes of long-term financial market performance and endowment asset management. He has been elected to Honorary Fellowships of the UK Society of Investment Professionals and of the Institute of Actuaries, and to Membership of the US Financial Economists Roundtable.
Are collectibles good long-term investments? "The Investment Performance of Emotional Assets"
Foreign exchange: Why Does the Carry Trade Work?
Dimson & Chambers-- "Retrospectives: John Maynard Keynes, Investment Innovator"
Dimson et al: "The impact of aging on wine prices and the performance of wine as a long-term investment"
Triumph of the Optimists (Chapter-by-Chapter Review)
And many, many more. See why we love him?
