The Business: Economists Have Discovered That We Have Been Misallocating Capital for More Than a Century. This Suggests Human Beings Are Irrational and Markets Inefficient

By Hosking, Patrick | New Statesman (1996), February 21, 2005 | Go to article overview

The Business: Economists Have Discovered That We Have Been Misallocating Capital for More Than a Century. This Suggests Human Beings Are Irrational and Markets Inefficient


Hosking, Patrick, New Statesman (1996)


Very occasionally, along comes some economic research that leaves you astounded. The London Business School has just come up with a study that a) is intriguing in an anoraky sort of way, b) could possibly make you a lot of money, and c) perhaps even explains something quite profound about being human.

The economists have tracked British stock-market returns over 105 years and discovered a curious and persistent trend. Investors who bought high-yielding shares over the course of more than a century would have become much richer than those buying low-yielding shares.

So what, you may say. High-yielding shares--those paying bigger dividends as a proportion of the share price--would obviously produce bigger returns. Not so, according to classical economic theory. All shares at any time have an identical anticipated percentage total return when discounted back to the present day. Low-yielders--which are usually companies seen as having more exciting growth prospects--are simply expected to produce more through capital gain (the increase in the price of the share itself) and less through immediate dividends.

Yet the anomaly persists, and has done for more than a century--in times of recession, in times of boom, in times of high inflation and in times of stable prices. Sometimes the trend disappears for a few years, as it did in the 1990s, but always it seems to return.

[ILLUSTRATION OMITTED]

A sum of [pounds sterling]100 invested in high-yielders in 1900--with the portfolio adjusted once a year--would have grown, with all dividends reinvested, and assuming no transaction costs and no taxes, to [pounds sterling]6.9m by 2005. The same sum invested across the share market as a whole would have produced [pounds sterling]1.5m. Put into low-yielders, it would have grown to just [pounds sterling]296,000. The numbers are much smaller after adjusting for inflation, but the differential--a factor of 23--is just as pronounced.

In essence, high-yielders have produced a return 3.3 per cent a year higher, on average, than low-yielders. Shove in the miracle of compound interest and it makes an extraordinary difference to the investor's great-great-grandchildren.

It is all very curious. It's a bit like discovering a system to beat the house at roulette. It shouldn't persist. The City employs thousands of expert fund managers who have access to all the numbers. Once the trend was spotted--and it was first remarked upon decades ago--the smart money should have moved to exploit it, prices should have adjusted, and the anomaly should have disappeared.

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