Investing rewards time, patience and diversification. So how many of these do YOU have?

The book “Triumph of Optimists – 101 Years of Global investment Returns” (Dimson, Marsh & Staunton) is probably the best book (and certainly most expensive at $135) that I have ever bought. It provides a comprehensive survey and analysis of investing through the 20th Century across 16 modern economies.

As one old saying goes “those who ignore history are bound to repeat it”. This runs into another saying that crops up from time to time in various market environments “This time it is different”. And, lastly, historian James Grant wrote “Progress is cumulative in science and engineering and cyclical in finance”.

Triumph provides lots of data to statistics-and-history-minded folk to help shape their investment philosophy. Lets start by looking at the Canadian economy over those 100 years. The following table shows the cumulative compound real (inflation adjusted -”R”) and nominal (as stated -”N”) returns on the Canadian equity market over the decades.

You will see a remarkable stability of post-inflation cumulative returns – essentially across the entire century, with the exception of the decade during WWl. However, not many of us have the luxury of living – and investing – across 100 years! So, lets drill down a bit to cumulative periods of time that are more commensurate with our own time horizons.

The next table breaks down the non-cumulative Canadian equity returns for every ten years, by decade, again pre- and post-inflation.

Analyzed decade-by-decade, we see a lot more instability in real returns than the running cumulative data in the previous table. Lets slice this in yet another fashion and look at the cumulative compound returns for investing in Canadian equity commencing at various points in the last 60 years.

Interestingly, the volatility in the nominal returns shrinks dramatically; however, what really counts is the real return, and it continues to have a degree of volatility.

So far, this data analysis attempts to speak to time and patience. But what about diversification? The diversification mantra speaks to various forms of spreading your risk, including, but not limited to, a bond portfolio, a globally distributed equity portfolio and an industrially distributed equity portfolio across the business sectors of the global economy. Lets start by looking at bonds. The next table compares the cumulative compound real returns on bonds versus Canadian equity across the century.

One of the purposes of diversification is to seek non, or low, correlation between the movements of two assets, in this case Canadian equity and bonds. This applies to either or both of the direction (the zig and the zag) and the amplitude of the movements. The next table shows the real non-cumulative returns of these two asset classes by decade.

Here, we see a mixed bag. There are some contiguous decades when the direction of returns in the two classes goes in opposite directions and others where the direction is the same but the size of the movement is different.

Now lets diversify to the global economy and see what happens. The next table compares the cumulative compound real returns on Canadian equity and globally distributed equity (in Cdn$) across the century.

Once again, lets drill a little deeper and see how these real equity returns compare and correlate by decade over the century.

The Canadian equity market generally out-performed global equity portfolios across the century. There were two decades when it did not, and in those periods the shortfall was substantial.

A final aspect of this international analysis involves exchange rates, which very much have been front of mind for Canadian investors of late. The next table shows the Canada/US exchange rate differences by decade over the century – expressed net of the two countries’ differing inflation rates. Negative values denote the Canadian dollar depreciating (net of inflation) against the US dollar.

Interestingly, this long view perspective reshapes our concern about this modern-day issue of exchange rates between Canada and the US. To finish our sweep of diversification, lets add a few of the above charts together and see what we get on a decade-by-decade basis.

The differences in the zigs (direction) and the zags (amplitude) of these three asset classes support a diversified approach to investing, and to parsing inflation out of the nominal returns that the media report.

Article published: Dec 2010