A lesson from investment history

Published by Richard Beddard on 06 October 2009.
Last updated on 24 August 2011

History book

Back in 1979 even the civil servants calculating the trade deficit were on strike, but Margaret Thatcher's incoming government knew from the uncollected rubbish in the streets and the pickets at hospital gates that the economy was in crisis.

Inflation had peaked at 27% in 1975 and corporate profits shackled by price controls had fallen to 8% of GDP, almost half their post-war trend. Between 1964 and 1979, the stock market had lost 32% of its value after inflation.

The Conservative Party's manifesto promised trade union reform, lower government borrowing and denationalisation, and it ushered in a decade of deregulation, free markets and tax cuts. These policies could, in theory, benefit investors, but as the 1980s arrived, the party realised Thatcher's inflation-busting shock therapy would make things worse before they got better.
"In explorer's language, the valley threatens to be rather deeper than expected," wrote stockbroker Rowe & Pitman in the summer of 1979. But the light across it is that much brighter."

STAR system

John Mulligan, an agricultural economist who had worked as a merchant banker, could see across the valley. If there was one thing the previous decades had taught him it was that in the long-run private enterprise would earn him a higher return than government debt.

His research led him to invest in fast-growing conglomerates such as Tomkins and Hanson, which could take over companies and make them more efficient. People looked on them as stocks that no portfolio should be without, although later in the decade, as the economy worsened again, some of these conglomerates collapsed under the weight of their debt, sometimes scandalously.

Mulligan was caught out by British & Commonwealth. Dodgy accounting had inflated the value of one of its acquisitions, Atlantic Computer, which was probably worthless when it was bought for £417 million. British & Commonwealth went into administration in 1991.

Such experiences convinced Mulligan that he couldn't analyse enough companies himself, especially as he was often working abroad. So he devised a system that would take the decisions for him, using the average of analysts' profit estimates to select companies with good prospects and cheap share prices.

He dubbed his algorithm the share trading and ranking system (STAR), which he later marketed to the public.

The calculating machine worked. An investment of £1,000 in the STAR in 1985 would have been worth almost £20,000 in 2000, compared with just over £4,000 invested in the FTSE All-Share index.

Although the STAR outshone the index, the index had actually performed extraordinarily well. The 1980s and 1990s probably exceeded investors' wildest hopes back in 1979.

Stagging new issues

Tom Owen, a law student at Exeter University in the mid-1980s, remembers the excitement as the government privatised company after company. "It was different in those days, he says, "There were no charts then. You had to make your own by cutting out the shares page of the Daily Telegraph every day and plotting [the prices] on a bit of graph paper".

"You felt you were on to something if you read that a share was going to go up. The height of sophistication was to subscribe to a newsletter on penny shares."

His first experience wasn't a government privatisation, it was the sale to the public of part of Wellcome in 1986. The process was the same, though.
British Telecom had already been privatised successfully, and the public could see there was money to be made as new companies came to the market. Only one person in four got the shares, but Owen was one of them.
"I applied for £1,200 worth, says Owen. "I had two credit cards, so I borrowed up to the limit on both of those, and the rest of the money was [student] grant money or whatever. Part of the excitement came from not knowing how much you'd get for them until you went to the stockbroker." Owen sold his shares within a couple of days, netting a profit of about £250.

"There was nothing guaranteed about it, he says. "You had to face the fact that the shares might go down, but you expected to gain. People got the idea, almost to the extent that they'd feel ridiculous not getting involved." Some applicants flouted the law by sending multiple applications from the addresses of friends and family.

Supposedly safe privatisations did go wrong though. When the government advertised its stake in BP, Owen waited until the last minute, as usual. "You never thought it was totally without risk, and there was no benefit to applying early," he says.
Then, on Black Monday, the market crashed and investors who had been more eager with their documentation watched BP's price plummet below the price they'd paid.

Although Owen bought shares in British Airways, British Gas and the companies spawned by the water and electricity utilities privatisations, as the sell-offs dried up in the 1990s, so did his interest in the stock market . "It wasn't really investing, he says. "There was no research to do, no charges and anyway a student couldn't afford to leave hundreds of pounds lying around in shares."

Feeling stranded

Steve Harrison was a police inspector in Twickenham when a frothy stock market, a crash on Wall Street and a hurricane in the south-east of England triggered a 20% two-day crash in the FTSE All-Share, Starting on Black Monday, 19 October 1987.
"You've got to remember that we still had typewriters, he says, "There was no internet. You couldn't telephone the stockbrokers. They'd taken their phones off the hook."

Like Harrison, Peter Temple, a financial analyst and writer, had done very well in the smaller company boom of the early 1980s buying companies such as Control Securities, a property trading company whose shares more than quintupled in a few years.

Fortunately, he sold most of his shares to buy a house, but the bust was still a pretty nasty experience. He says: "It was a particularly short and nasty bear market. The stocks that I had left in the market were absolutely crucified."
Temple profited from smaller companies again between 1991 and 1996. He discovered Northern Leisure, which ran discotheques, when he was writing the City column for Club Mirror, a publication covering the nightclub sector.

Having bought at 9p and sold at 36p, he thought he'd done well. "But the sting in the tail was that it eventually went to 180p, he says. "I'd have been seriously in the money if I had actually hung on."
But, having seen the euphoria of bull markets evaporate so quickly in 1987 he'd become cautious and, sensing more euphoria in 1996, 1997 and 1998, he switched most of his shares into with-profits funds and bonds, a decision that would be vindicated in 2000.

Retirement plan

As early as 1975, Steve Oakley had decided to take care of himself in retirement. He thought the state wouldn't be able to pay a decent pension because of the UK's ageing population. Then, in 1980, the government confirmed his doubts by decoupling the state pension from average earnings and coupling it to inflation.

As a squadron leader and logistics expert in the RAF, Oakley had been trained as a planner, skills he later used in the private sector and, briefly, as a financial adviser for Towry Law.

He says: "[At the Start] I was very naive. My dad was a miner. He didn't have money, let alone shares, so I've had to do a lot of my own research."
His opportunity came when, in the early 1980s, Brown Shipley offered one of the first regular saving schemes in a personal equity plan (PEP), the tax-free precursor to ISAs.
He says: "Having seen that the charges were high and the big bid/offer spread, I thought if I went for what a lot of people were pushing, which was capital growth, then when I retired I'd have to switch from capital growth into income.

I thought that's no good, because I'm going to be paying another 5% at that point. "I took the view that if I reinvested the income, the odds were that I'd get similar capital growth to a pure capital growth fund."
Ignoring most financial commentators, and their exhortations to buy and sell, he squirrelled money away into PEPs and later ISAs, adding cheaper funds from management firms he trusted - companies such as Artemis, New STAR, Rathbones, LionTrust and Henderson.

Commission problem

In 1994, Martin Campbell was working for Norwich Union. He was in a similar position to Oakley, who quit financial adviser Towry Law in the mid-1990s because of its increasing reliance on commissions to reward its advisers. The firm now operates a fee-based model. The problem was that the biggest commissions were often paid by the worst fund managers, often banks and insurance companies.

"Marketeers are supposed to find out what customers want and discover a way to deliver in such a way that you make a profit, says Campbell, "Yet all the research I was doing said that customers want simple, straightforward and good-value products."

However, such products didn't support big commission payments. Every time he proposed one, his bosses would remind him that the customer was the adviser, not the man paying the premium.

Richard Branson saved him later that year when the entrepreneur proposed a joint venture to Norwich Union that would offer investment products directly to the consumer. That venture became Virgin Direct. Campbell was recruited as product designer, and his first product was a PEP with a new engine.

Until the mid-1990s, index tracking funds were the preserve of large pension funds, but by tracking the FTSE All-Share index instead of trying to beat it, Virgin realised it could offer a fund with an annual management charge of 1%. Compared with charges of between 1.5 and 2% and initial charges of up to 5% for actively managed funds, that looked very cheap.

"It was easy to demonstrate that customers were being ripped off, says Campbell. "The reason they were being ripped off was that there was an adviser in the middle of the transaction.

Since he was probably recommending active funds, the majority of which underperformed the market, he was probably not adding any value."
Virgin was fortuitous in launching its PEP in March 1995. The bull market was already a year old, and it would not be seriously derailed for five more years. By 1997, Virgin Direct had the most PEP investors in the country.

As soon as it launched a regular savings facility, Campbell contributed. When it launched the Virgin pension with the same tracker fund, he took out the first one. Then came the dotcom crash and the good times were over for the FTSE All-Share tracker.

Between 1994 and 2000, the FTSE All-Share doubled. But it's now down more than 20% from its 2000 levels.

Bad timing

Ben Tyler has good reason to remember the year 2000. It was the year he was crowned Online Investor of the Year by Interactive Investor.

Tyler, a chartered accountant and dedicated technology stock trader, had used a quality filter he'd invented on 5 November 1999 to trade his way to the best performance of the year. "I should have left the poker table in February 2000, he says, when one Friday the stock market rose 6%. "It was panic buying," he says and a very strong bearish signal.

He got out in March, investing the money he'd made from companies such as Baltimore Technology in the likes of Boots. But he was far too early. On many occasions between 2000 and 2003 the market appeared to be recovering before plummeting to new lows, and by March 2003 he'd lost a lot of money.

Today he uses a revised version of his Firework Formula and, just as Black Monday turned Temple into a more cautious investor, the meltdown in technology stocks focused Tyler's attention on avoiding market panics.
His formula has evolved beyond its original focus on growing sales, trend-following and positive news flow to include old-fashioned virtues such as tangible net asset value and liquidity.

As prices had crashed, Tyler was unable to find buyers for some of his smaller companies. He's unlikely to buy many small, illiquid stocks again.

Although he hadn't invested in technology stocks, Campbell's memories of the crash in 2000 are equally vivid: "At first you kind of think 'Oh my God, it's going down. It's going down. It's going down.' But I'd spent enough time thinking it all through to know the worst thing you can do is take all the money out then. You just relied on the 'it's time, not timing' adage and just sat tight and rode it out."

But a change of management and strategy at Virgin meant he was out of a job, and the first client for the public relations and lobbying company he'd just founded was a low-cost online fund supermarket selling direct to investors. The shelves were stacked with actively managed funds.

Now that the price of active management had come down, Campbell discovered Anthony Bolton and switched his ISA into Fidelity Special Situations. The success of Bolton led him to question some of his old mantras and propelled him into the arms of another STAR manager, Invesco Perpetual's Neil Woodford. Although most of his savings were in his pension and still tracking the index, he'd taken his first steps into active management.

Caught in a trap

Geoff Weir is still waiting for his last payment from the liquidators. He remembers 2000 too: it was the year of the Hatfield train crash, which took the lives of four people and triggered the demise of Railtrack, the company that ran the UK's railway infrastructure.

Weir wasn't just an investor, he had worked for the company all his working life, Starting off as a mechanical engineer at Bounds Green depot in 1971 and ending up as privatisation manager in Swindon.

It was his job to brief staff, and by the time he left, 94% of Railtrack's employees were shareholders, as was Weir.

For investors, the privatisation was a success, as Railtrack's share price rose from £3.80 to more than £17, taking the value of the thousand or so shares Weir owned to £17,000. But in 2001, the government re-nationalised Railtrack and he got just £2,600 in compensation.

"I'm still very annoyed", he says. Railtrack's share price had been falling since Hatfield. Speed restrictions and engineering works were costing so much that the company was losing money. In 2001, the government withheld funding, applying to the High Court to put the company into administration.

By withholding funds the government precipitated the collapse in Railtrack's share price, allowing it to be re-nationalised cheaply, says Weir. He acted as spokesman for a committee that raised over £3 million to take the government to court.

They lost the case and Weir no longer invests in regulated utilities. These days he prefers multinational companies, such as miners Rio Tinto and BHP Billiton, which he believes are more free of political interference.

This article was originally published in Money Observer - Moneywise's sister publication - in October 2009.

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