The golden age of returns is over

33:10So they were riskier than the bonds we have today. Well, I think also equities may have been safer because a major part of the stock market in both the US and the UK were railroads. And the railroads controlled a revenue flow and had monopolies. and maybe at that time were relatively safe. So the equities were the bonds of the time in the sense that they were a safer asset class. I thought I'd want to push it too far. Yeah, yeah, yeah. But it helps reframe it. So what you're basically saying is, though, that the risk premium, this point of if you take risk, you should be rewarded in the long run, that has persisted over hundreds of years, potentially.

33:55We believe it has persisted, but with a lot of variability. the reason that you should expect an equity risk premium is that equities are risky. If they're risky, bad things may happen. And it's because of that that you expect on average to get a reward. But over a five-year, a 10-year, or a 15-year period, the very nature of that risk is that you may do badly. If there was not a chance of you doing badly for equities, then they wouldn't offer a forward-looking risk premium. So you sometimes see these charts of what the equity premium was, the realized excess return of equities compared to bonds over rolling periods, and you find sometimes equities do worse, sometimes they do better.

34:44We really need a lot of data to form a judgment about that. How much data? I know in the briefing call you threw some quite big numbers around in terms of what you think would be acceptable amounts of data? I think in the end you have to fall back on some intuition as to what was going on but these equity risk premium numbers are used around the world for setting allowable rates of return so setting the rate of return, which it is reasonable for a railway company or a water company or whatever to charge to recover what look like reasonable returns for shareholders. And that, I think, means that those numbers are fearfully important because people take them.

35:39And if I ask you, what is pi, you can tell me it's 3.14159265358 something like that. I'd have stopped at 1.4. But it's a number. The equity premium is the pi for financial mathematicians. And it's not a constant like that. It can vary over time. So people look for great precision in these numbers, but they're only a starting point. But in some locations, those starting points become very important. They influence what financial regulators permit for making projections as to what the returns will be for investing in the source of products that you talk about when you talk about your favorite index funds.

36:33So they use those numbers and anchor to them. my take on it would be that looking forward from where we are now in the beginning of the second quarter of this century that people should be anchoring on numbers which are lower than we saw uh in the 20th century and documented in our triumph of the optimists book i was about to ask uh we always you always hear you always see written past returns are no guaranteed of future performance, but how can we put so much faith into, as investors, not as academics, how can we put so much faith into past performance numbers and average when the beginning of this, since 2000, the returns have been quite as good?

37:18And also with all the changes in the stock market, how can you really have so much faith in these numbers, especially in a time of like American exceptionalism and all these things? How can we think that the next century will be similar to the last century? uh we shouldn't the the the i don't know where the phrase comes from but they talk about uh history not repeating that history rhymes yeah and i think uh there are ways in which we can choose history as our starting point so uh if you were guessing um the weight of um uh items for example the used to be a guess the weight of the cake competition at the local primary school at the end of our street um and i won that once um so you had to write things down and they they passed you if you arrived late uh a uh the sheet of paper with everybody's guesses above it.

38:16I have no capacity to guess the weight of a cake. So I eyeballed the numbers and I wrote down the average. And a short while later, they broadcast who the winner was. This was their name at the bottom for this. It was just that I thought that the average would be helpful. So that doesn't mean to say that I'm fearfully insightful. And I think there's something similar going on, if you want to know what the equity risk premium might be, you would ideally like to average everyone's thought processes. You can't do that. But you can look at history. So it gives you a starting point. And then you've got to ask yourself, well, what's it going to be like going forward?

39:03In Australia, which is a winning stock market over the long haul, there's quite heavy reliance on the very high returns that have been achieved. So when there's a company which is being regulated, being told by its regulator how much is reasonable for shareholders to earn, they like those big numbers. But if numbers are very low, suppose you take a stock market which has just subsided, Argentina. Movedy in Argentina says they would look for returns from equities which are negative. It's just that the country did badly. So I think that history is a starting point. You've got to be quite cautious about it all.

39:52And once these numbers get used by regulators, you've got two sides to this. You've got the regulator and the regulatee, the regulated utility. And things can go wrong, as we've seen in the news very recently, or at least as we speak now very recently that regulators can get things wrong and get wrapped on the knuckles. I would like to ask you around how you feel American exceptionalism has surprised you in your research. Do you feel that this is a force that can continue? And if it doesn't, what does that do to someone like me who's globally invested? Well, to talk about American exceptionalism, let me go back then to before we had published our book, Triumph of the Optimists.

40:36And at that stage, just about all of the business schoolie textbooks in finance would have a chart which shows what the long-term history had been for investing in the stock, bond, or cash market in the United States. And that would be in an edition of a finance textbook, which might be in Hungarian or in French, whatever. And so our intuition on that was that we shouldn't really be relying on evidence for the US. We should be looking elsewhere. And so we need to deal with the question that the US had done very well. We called our book Triumph of the Optimists because the optimists, if you go back to a hundred or more years ago, were people who thought that risky shares would give them higher returns.

41:39And they triumphed over the 20th century. And we called it Triumph of the Optimists because people investing in shares had done so very well, it was a sort of caution that you shouldn't expect that to continue. and where had they done well more than anything else in the United States so the U.S. was a very high performing market and it seemed obvious that one should not be projecting that the U.S. would continue to outperform because if we all agreed that America will do well prices will go up to the point at which there is a new level but you wouldn't expect further outperformance. so we don't make forecasts we are evidence-based researchers we presented the evidence and the reader can make their mind up but what actually happened was that the US market which you thought would be much more average going forward ended up performing very well in investment terms so the first quarter of the 21st century was very good and when we started doing our presentations of the 1925 edition of our book we ended up showing what the results looked like and then we added on a little chart showing just what had happened in the first few months of 2025.

43:10So it continued to look good momentarily. Then there was a big dip. Then there's been a recovery. Who knows what the second quarter of the current century will look like. But the notion that America should continue to do well because it's done well in the past, that's a very American statement of sort of optimism about the future. A lot of Americans believe that. But nevertheless, over time, the proportion of assets held by American institutions in non-US companies, for pension funds, for example, has declined a great deal. They used to have nothing in overseas securities, and now have a substantial proportion, over 20%.

43:59So there was a belief that investing globally would make sense for Americans. They were wrong. But you can sometimes make correct decisions, and then you turn out to be unfortunate. And those who stayed in America did better than those that invested globally. What would we expect looking forward? We don't know which markets will do well. What we do know is that if you diversify, you end up with somewhat less risk than if you don't diversify. It's probably my favorite chart. It's that wonderful flow of markets over time and shows the impact. It shows Japan bubbles up in a period and then declines in relevance.

44:44And the fluctuations of the market impacts over time, it shows this slow death of the UK from 25 % to 4%. if as we are now where the u.s market represents about say 60 65 of a global index if america does decline and someone is buying the whole index what would that do to their returns do you think i mean do you have a way of saying is that going to be a really painful process for that individual or would the rest of the world pick up america slack now let's be clear-headed about what happens when a market drops in price, then if cash flows haven't changed, then our expected return looking forward will be better.

45:27So as we look back, prices drop. When prices drop, you will do better going forward. So we don't know. People making international asset allocation decisions are influencing that. You're not influencing that because you've publicly posted that you don't think about any of that stuff. You just buy the world. And I'm very sympathetic to that point of view. But there are people who are thinking about the performance of different countries. And what you see is a kind of weighted average of all the opinions that investors and other professionals have. You say that index investors have gotten a free ride on the people who perform price discovery.

46:19So these people who think about it, people like me, have basically ridden on their hard work. Do you think there's a point where the index becomes too big or too much of a problem that it kind of overweighs the active component? Well, there is an argument that now is a better time to be an active manager. Because there are so many people who are just clinging to the index. But what you're focused on, I think very wisely, is doing all of this on the cheap. So what every investor wants is some exposure to the market. We sometimes call that return beta, beta, beta. And you also want some alpha, which is outperformance.

47:08Now, alpha from being clever, it's difficult to get right. People make mistakes. But there is one form of alpha about which you can feel very confident. That's negative alpha. The more you pay in fees, the more you will be adding a negative amount to the return that you get from the markets in which you're investing. So you're taking a bet on alpha. You are projecting large costs for some investors and low for yourself. And as you pointed out, those costs are becoming extraordinarily low for people in some mature markets, especially the United States. I've never really thought about it like that.

47:54I've always described it as the only thing we can control is fees. So we should try to reduce them. But this idea that you can generate an outperformance through reduction of fees. And by betting on someone who says, I'm smarter than the market, you're sacrificing that certainty of return by basically saying, I'm going to pay you an extra fee to try and be smarter. But that's uncertain and pretty hard to do. It's hard to do. There are clearly talented people who have great insights. You may pay quite a lot for that. so if you really want the people with the best insights they're probably people who work for hedge funds and you've had one or two of them on your show as well they all say this is the year the actives are going to win and they don't could i be as well just to ask you how how you invest or how you see you know asset allocation for yourself uh we we are heavily invested in the one of the Vanguard Global Funds.

48:54So, you know, I had known Jack Bogle a little bit. That's the name drop down. That's so good. That's so cool. I've never met anyone who's known him personally. So, yeah. So, well, I had been, just when my PhD was finished, I'd been at the time visiting in the US and became aware of the startup of index trading but didn't invest through that route because it's complicated and anyway I didn't have much money to spare but so we're invested with Vanguard you highlighted a lower cost but less widely distributed alternative. Oh you really watch some of the content thank you very much yeah i think at the time the investgo fund you're talking about which was a global global fund it's got much bigger now but yeah i mean it's it's a tiddler i think that the uncertainties of a small fund have to be in people's minds at the same time as a different headline cost but um it costs us so little um i mean 0.2 on a vanguard nowhere near as much as that.

50:15Are you buying through a US? No. Buying through, because I started investing early. I was on the, chairing the policy board at FTSE Russell, which is part of the London Stock Exchange Group. And the person who used to sit beside me was the European head of Vanguard. And so I was an early investor. You get that sweet connection. It was not a special deal. The only way of doing it was as an institutional investor. And he just opened the door for me, but there was absolutely nothing special. This is not like Tony Blair's wife getting her clothes at a discount. That was in the morning's paper, if you missed that.

51:03So there was no special discount, but it was just remarkably low. And yet there are lower cost alternatives to what we do. And, you know, I'm very much in favor of investing for the long term. But just to go back to the earlier question about not being clear on when performance will be good and when it will be bad. I think the best people to invest for the long term are ones who hope for good outcomes and can live with lousy outcomes. so um if you you know if you were saving up for um uh children's school fees or something like that your time scale is not very short but it's perhaps not that long if you are saving for grandchildren or you've got more money than you need and you visualize this going to charity or whatever, then you can take a very long view.

52:15And so I'm all in favor of equity investing and low fixed income content. Yeah, and you're saying that you expect the returns to be lower. If you had to make a bet, you don't like to forecast, but you say people should at least build into their minds that the returns of this century could be lower than the last. Do you still think that you'll see that persistence of equities the risk premium and them outperforming other asset classes and even though it's low it's still going to be potentially the best bet yes over the long term and probably so if i think in terms of my current employer which is the university of cambridge you have some very wealthy colleges super wealthy colleges and they can afford to take quite risky investments in the hope of high performance.

53:08Then you'll have some much less wealthy colleges. They're ones that came into existence relatively recently. And for them, if they didn't have the money to repair the roof over the organ, the costs would be just too much. And so you can't have that money that may be needed if you're unlucky with the weather and the rest in the near future. That has to be invested rather more safely. So the investment world favors the already wealthy. And it favors the already wealthy who include people whose time horizon is long because they've given money away. So the college that has received gifts is a college which can think about things over hundreds of years into the future.

54:08Yeah, this leads me on to your work with sovereign wealth funds, which I think are a fascinating instrument and some really interesting insight. Did you work with Norway? I worked with Norway. I chaired the strategy council for Norway. for quite a long time. Norway decided that once money started coming in from the relatively recently discovered reserves under the sea in the North Sea, that the money that had come into the country from oil belonged to the people of Norway, didn't belong to the wealthy rulers. and so they set up a structure i think that's very important you need some sort of structure otherwise people make knee-jerk decisions money initially was in cash then it was held in bonds for a few years until it got a bit bolder and they moved into equities and there was heavy reliance on the early work we'd done actually before publishing triumph of the optimist the privately published books that I told you about.

55:26And so I got drawn into Norway, giving some guidance on what performance looked like over the long term. And then found myself after a few years chairing the Strategy Council. Well, the Strategy Council is not an asset manager's strategy group. I was doing this for the owners. The owners are five point something million Norwegians who delegate to their government and the government delegates to a department which is the Ministry of Finance. So my role was thinking about the big picture questions with other members of the Strategy Council and spent quite a long time doing that and thinking about how one might invest And I must say that the option of going to an index fund provider that is truly global and has securities all over the world, that's essentially what Norway does as well.

56:29when you are that big and that wealthy, when you own about 1.5 % of the equity of every company in the world on average, you don't spend your time worrying about whether a particular company is going to do well or badly. You think about the big questions and that's how we started out. Is it the largest sovereign wealth fund on the planet? Am I right in saying that? There are two very large funds. There's that, and then there is the Japanese government pension fund, which you might regard as being in the same sort of league. It started later and grew fast. But as a pure sovereign wealth fund, it is the biggest.

57:13And they're globally diversified through equities as a large portion. Globally diversified, but interestingly, in the early stages, they were gradual changes. So there were questions like, how much should be in Norway? How much should be in Europe? How much should be in other countries? The answer on Norway was nothing. And they set up a separate Norwegian fund that would invest in Norwegian stocks, because otherwise this huge global fund would just swamp the Norway. We should do something like that in the UK. Well, we should have with the North Sea oil, because we had the same... Were you pulling...

57:56Were you despondent at the time that you were doing this work with Norway and you were looking at the UK going, why are we not doing this? The UK's failure to take advantage of its oil was somewhat earlier than all of this. My involvement was after we'd produced our first book in 2000. but I think that the sovereign fund is very focused on governance that has some upside people who are the owners that's the five million Norwegians know exactly what's going on if you look at other countries they've very often gone for other sorts of strategies so some will spend on infrastructure and say that's for the good of the people and they'll build roads or there may just be a setback in the local economy and they'll draw money out to help on that what the norwegians have is a spending rule and spending rule used to be four percent is now three percent of the fund smoothed over time so that is like saying um you've got the good fortune to have chosen your parents with great wisdom they've left your trust fund but your parents don't really trust you to to be let loose with your trust fund that they've graciously bequested to you you can spend just a small amount each year so um it should be under the returns i'm guessing yes like the trinity study almost isn't it it's like the four percent rule or something but it's yeah it's it's genius and so they think so long term and it feels like a lot of things we're lacking yeah you know i would have looked the foresight to protect it for future generations is great what that they do not describe bit as mimicking or doing something different from Britain.

1:00:00When the structure was set up, it was to avoid Dutch disease, not British disease. The Dutch disease was the Netherlands found and exploited oil somewhat earlier than the Norwegians. They had a lot of money that came in, and there was domestic inflation, people felt wealthier, they spent a lot in the Netherlands and the Netherlands never really achieved the sort of ultra-long-term benefits that the Norwegians decided that they wanted. At the minute, the UK is trying to create a system whereby auto-enroll pension schemes create almost like a home bias or they're pushing them towards putting a certain percentage of their holdings into UK assets.

1:00:46I read a paper recently as well that argued that a home bias is a good thing for domestic investors. There's a guy called Ben Felix, he's a great YouTuber and he presented this idea that this paper put forward that you should have 25 % of your pie in your local market. Do you think these kind of approaches make sense when you're talking here about global investing? No, they're wrong. Okay, I'm glad to hear that. So do you think the UK's approach around pensions then is wrong? No, the UK is doing it wrong. You do not want to have global investors that fail to diversify. What you want is to have your shares, the shares will exist, it's a question of who owns them.

1:01:36and what you want is for people from outside the UK to want to buy shares to the same extent as British people might want to buy shares from other countries. So I think good practice for managing pension funds and what the sort of more senior members of your audience should want is to avoid this pressure to invest locally and to invest globally and to maximize diversification. Yeah, it's a shame that it's happening within the default funds, which are by design the funds that people just get slapped in that don't know what's going on, and then they're being dictated to around. But most of those people are people who either worked for or did work for British companies.

1:02:29they are already overexposed to the performance of Britain. If Britain does well or does badly, people in the country will do well or do badly on balance. So there's an argument as to why people in that position should want to have international exposure. So I think the home bias that's being encouraged by the government is a mistake. Have you got examples of markets where that's been attempted before, where what I get the impression from Rachel Weaves is almost like we want to jumpstart the UK market, because if we put pension funds into them, maybe the prices go up then, and then that makes it more attractive to international investors.

1:03:11It's kind of, it's like a chicken and an egg thing, isn't it? I don't think she could believe that it will jumpstart the market, because pension funds in Britain, which were once very large, are not very large now. So we're talking about either defined benefit plans, that's the pension you get if you are in a long-standing, for example, public sector pension plan, and those are getting less important, or they are defined contribution plans. Those are ones where you as an individual decide how your money will be invested. And what you're describing as organizations where there is a default, you do usually have some choice.

1:03:59You can choose, as unfortunately most people don't. And those people probably should be trying to invest internationally because institutions can invest internationally at a lower cost than individuals who, if they've got an ISA, are more likely to be investing locally. So they are exposed to the UK economy and probably more likely to buy a FTSE 100 or some other British exposure for their investments. So probably they would be better served by having exposure, which is ex-UK. you actually blew a little bit hot and cold about the ex-UK chart that you had at one stage. You know my content better than I do.

1:04:55This is super impressive. Thank you. Do you feel that your work is in any way misrepresented or misunderstood? Is there anything that you'd like to say to people about the work that you do and how they should absorb and use it?

1:05:11um well i i think i'm probably speaking for my two co-authors paul marsh and mike staunton as well as myself that we want to portray the data we will torture the data to give us answers to contemporary questions but we don't produce forecasts we don't give recommendations except of a very light touch nature. So people who want to look at the book, I brought a copy with for you. Thank you. So the book itself looks at all sorts of different issues. And you might encourage them just to learn more for themselves. But I don't think we are misrepresented. Sometimes people use our data in a way that we wouldn't use it.

1:06:10So, for example, I gave you the illustration of Australia, which has done very well. People grab that. And I think sometimes people rely too much on individual countries. They should be looking more at our world numbers and then adjusting them a little bit. If you focus on individual countries, you could take one country like the Netherlands, which has had very good investment performance, and a country like Belgium, which has had lower performance. And if you were just looking at the stock market as the guide to where you should invest, if you were trying to work out whether you should build a warehouse on a road somewhere near the border between the Netherlands and Belgium, them, you wouldn't want to have a different cost of capital for one that's 100 meters down the road that way or 100 meters the other way.

1:07:06You say they must surely be evaluated in the same way. So there is a danger from focusing on individual countries. And yet, the different experiences of these countries, so we have altogether, including equity markets, which don't have bond markets, over 90 markets altogether, for which we have data, but not going back 125 years. You could learn something from seeing what the different experiences of different markets. I think that's important. Does it not matter how big the country is if you say don't look at countries overall? I mean, because, for example, America, California is the same GDP as lots of countries, or bigger than lots of countries.

1:07:53So does it not matter if the country's bigger? Well, I think the stability of the United States, which is bigger than all the other countries put together in stock market terms, does make it less problematic if you have home buyers in your portfolio than would otherwise be the case. And many countries have a large proportion of stock markets represented by companies that are just in two or three industries. yeah something from the research with the concentration of certain markets is well i constantly hear that america is so concentrated over concentrated then you look at other markets and you realize there's concentration issues it's one of the least concentrated markets is great yeah but the reason people think that america is concentrated is that large companies are american So of the 10 largest companies in the world, nine are American, and one is in the Far East.

1:08:58So it's a problem that you should want to have. America is so broad that it provides enough diversification compared to what you would find in any other single country. but if you had lots of initiatives to drive people towards home-biased portfolios, that for some countries could be very costly. It could drive them into just a couple of sectors. Have we seen concentration of the levels that we have now throughout history? Would you say going back that you always experience that the winners win in a sense? um no the the the last few years have been remarkable for uh large companies doing very well so those large companies were american and excluded the year that we that hasn't uh finished yet the recent past um those large companies had done had got bigger and bigger and they got bigger because they were bigger, but also their performance was high.

1:10:16And so they've had a huge impact. And the net effect is that America, at least until the beginning of this year, was getting stronger and stronger in terms of its investment returns and its overall value. So this question of concentration is something which should concern people. But those who worried about being overweighted in American stocks, year after year after year, for quite a number of years in succession, were worse off if they tried to underweight America because it looked so big. It's very difficult guessing which markets will do best. market timing is costly and buried inside those decisions to reallocate money from one market to another are costs you never really see.

1:11:13Damon, what do you think about that? You're a big fan of Ooi Dimson's work. Massive fan of Mr. Dimson and his colleagues as well. There's three of them that were part of it. But yeah, it was kind of surreal to sit there with someone that I've quoted their work in a lot of my content and for him to spout off a load of my videos because he'd been watching my stuff and yet again world-class expert sits there and talks about buying a global index fund is i feel good you know really reassured you built your whole life around it yeah i do think that people need to listen to that point though around market returns and how he expects them to maybe not be as good in this century as they were before i think a really useful exercise is to get a good compound interest calculator and just play around with different figures at different levels so you You can make sure that you're on track with your goals.

1:11:58If I do say so myself, we have a really good one. I'll link it below. You can add fees into it and it will track inflation and these kind of things. He's going to stress test it with different amounts so it's not just the 10%. You can change the... Yeah, the real returns he was talking about at nearer 5 % and then tweaking that down and up just to make sure you're on track because I do think one of the mistakes that people make around his work is they just quote the headline figures without acknowledging that certain centuries weren't as good. Yeah. And focus on America and not global. Like, yeah, there's a lot of different returns.

1:12:32Yeah, they focus on America. Sorry, I thought you were telling people to do that. No, no. Everyone focus on, no, don't. Focus on global. That's what we think. Well, that's what we do. Yeah, that is what we do. Yeah. But we don't give financial advice. No. That's what we don't do. No.

1:12:47Before you go, it's really important to remember that nothing we said there was financial advice. The reason it's not financial advice is because it's not tailored to you. If you want advice that's tailored to you, it's worth speaking to a financial advisor. As with everything financial, please do your own research. We really encourage that because no one cares more about your money than you. I'm Damo. I'm T. Jack and Ben from Flowspire, film and edit for us. Ruth's app producer and Will is the co-founder at most. See you next week.