Every child has heard similar words. You want that delicious-looking cake? A new toy? “Money doesn’t grow on trees!”
It’s a valuable life lesson, similar to the ‘no free lunches’ stuff we all have to learn in ‘Investment 101’. But for some reason we occasionally allow ourselves to be convinced that lunch can be free, that money does grow on trees.
Alongside this month’s IPE we are publishing a supplement that looks at ‘risk-managed equities’ – chiefly minimum-variance strategies. Appetite for these is a strong theme in institutional equity portfolio management, as is the relentless desire to own companies that pay and grow a dividend – addressed in our Investing In section.
This behaviour is elicited by a combination of low bond yields and depressed expectations for medium-term economic growth. Investors who cannot get income from governments or credit spread from corporate bonds are hoping to find richer bond-like cash flows from the equity part of companies’ capital structures. And for fear of the low-growth outlook, they insist upon getting today’s profits up-front as dividends rather than having the faith to let companies re-invest them, reaping the fruits via capital appreciation.
But these two positions are contradictory. The spread of a dividend yield over a bond yield is a premium for taking investment risk. Stop taking that risk and the earnings growth that pays the dividend will wither away. The yield you bought will mean nothing. “Money doesn’t grow on trees.”
In Strategically Speaking last month Yves Choueifaty made a similar point when he imagined an economy whose investors all pursued minimum-variance portfolio strategies. “Every CEO would aim to reduce the volatility of cash flows to attract capital from investors,” he reasoned. They would buy T-Bills instead of spending on factories or R&D.
We might dismiss that as fantasy – except that it is already happening. Andrew Smithers, a UK economist, has shown that US non-financial companies are returning near-record levels of cash to investors while investment in capital stock is at multi-decade lows.
One asset manager in this month’s issue says that companies are sitting on huge amounts of cash because they have such “limited opportunities to invest for attractive returns with confidence”. But that confidence is not just confidence in the broader environment for growth, but also in shareholders’ willingness to bear the risks associated with investing for growth. That confidence is being destroyed by the scramble for equity income and low volatility.
This month’s Strategically Speaking guest, Standard Life Investments CEO Keith Skeoch, blames the lack of corporate spending on the short-termism of policymakers, but adds: “Investors need to offer management some certainty by taking a longer-term view, as well.”
The growth managers in our Strategy Review reminds us that we are being paid to do that at the moment: capital investment is so unloved that growth stocks trade as if they were value stocks. They are talking their books, for sure, but the numbers don’t lie because they express a fundamental truth: one cannot extract a rent from non-existent economic activity. Or, to put it another way: “Money doesn’t grow on trees.”