《金融时报》无风险回报，平淡才是王道

The title of this piece is a play on the expression “risk-free return” used to describe the return on investment which can be obtained without incurring any risk to the capital sum invested. Prior to the current financial crisis, this characteristic was generally assumed to apply to sovereign debt in the developed world.

The efficient-market hypothesis (EMH) asserts that financial markets are “efficient” in that the only way an investor can achieve higher returns is to take on more risk. But this is not necessarily true in practice. Research by Robert Haugen of Haugen Financial Systems and Nardin Baker of Guggenheim Partners shows that the least volatile decile of stocks generated annualised total returns of 8.7 per cent, while the most volatile decile lost 8.8 per cent a year. These results seem flatly to contradict the risk/return bit of the EMH.

Another study by Goldman Sachs brings in fundamental quality – defined as cash return on cash invested, or Croci.

It created portfolios based upon Croci performance and found that market returns increase with relative Croci. Better companies made better investments.

But why can “quality” shares outperform like this when EMH postulates that only more risk can drive superior returns? Part of the answer lies in investor psychology.

Imagine you have a gravely ill-loved one, but you can purchase treatment that would enhance their chances of survival by 10 per cent. What would you pay for it?

Research suggests that this depends upon their starting chances of survival without the treatment. If their chances were 50/50 then a 10 per cent improvement would certainly be valuable.

But if their chances were zero, I’d suggest most people would pay more to improve that to 10 per cent.

Similarly, most people would surely pay more highly for certainty – if the relative had a 90 per cent chance of survival, but by paying you could take this to 100 per cent.

This goes some way towards explaining why investors will buy a bond which yields less than an equity in the same company. They desire certainty of outcome: the bond will pay a certain coupon and be redeemed for a certain value a certain time. By contrast, dividends from the equity may vary or even disappear and the price of the shares is unpredictable.

Daniel Kahneman, the psychologist and behavioural economist, illustrates this point in his book Thinking, Fast and Slow using the chart above.

The solid line is the “decision weight” – the psychological importance attached to each level of probability, derived from laboratory experiments. You can see that from about zero to 30 per cent probability of survival, the relative will pay more for a given level of probability. From about 30 per cent to close to 100 per cent they will underpay, but there is a sharp increase in the relative amount they will pay from about 90 per cent probability to certainty.

In invesing, the near-certain bit just before 90 per cent is the world of low beta/high quality stocks. They have bond-like returns and low share price volatility, but they are still stocks with uncertainty about share price and dividend payments.

This helps to explain why “boring” quality stocks tend to be consistently under-valued, and that under valuation is what helps to produce superior performance.

The upshot of all this is relatively simple, but nonetheless startling. Rather than seeking superior portfolio performance by chasing high-risk stocks (“return-free risk”), investors should seek out “boring” quality companies which have predictable returns and superior fundamental financial performance, and take advantage of their persistent under valuation relative to those returns to buy and hold them.

Terry Smith

Financial Times