Investment Policy and Index Numbers

It is more than 25 years since the subject of Index Numbers and their application to Investment Policy was last discussed by the Faculty (See C. M. Douglas, T.F.A. 12 and A. C. Murray, T.F.A. 13). When these papers were written, ordinary shares were only just beginning to be recognised as suitable investments for Life Assurance Funds. Douglas and Murray anticipated that as ordinary shares became more popular with the offices, index numbers would be useful for the following purposes:— (1) Assessing the current position relative to the trade cycle; if this could be achieved, the timing of share purchases and sales would be greatly facilitated. (2) Comparing the prospects for the different industries. As a result of these original papers, the Actuaries Index Service commenced in 1930. In this paper, the authors review developments that have taken place in investment policy over the last 25 years, and study the contribution to these policy considerations that the Actuaries Index and other Index Numbers can provide. The paper is divided into five parts as follows:— Part I deals with the various economic and market factors which affect the level of share prices; usually share prices are closely correlated with the level of business activity. Sometimes, however, as in 1949 share prices fall, due to conditions overseas, without a corresponding decline in business activity. Practical uses of the Index are discussed in Part II. Particulars are given of the numerous applications of Share Indexes to problems arising in day-to-day investment management. In this part also, the authors describe certain techniques, developed to deal the first objective of Douglas and Murray (i.e. that of assessing the current position relative to the trade cycle). It is suggested that these techniques, which involve comparison of the Share Index with Activity Indexes, and with the Financial Times Industrial Profits Tables, merit investigation, and provide an interesting field for research. Finally, details are given of an investigation into the results of a portfolio of ordinary shares held over 25 years. This investigation shows that the appreciation of ordinary shares, both as regards capital and dividends, has to a large extent kept in step with the very considerably increased cost of living, sustained during this period. In Part III, reference is made to recent Institute Papers, where the principle has been developed of selecting investments according to the “expected yield” (See J. B. H. Pegler, J.I.A. 74 and H. G. Clarke, J.I.A. 80). An attempt is now made to extend these ideas and consideration is also given to the link up between the “expected yield” of an ordinary share, the “earnings yield”, and the return provided by new money invested in the company concerned. Part III concludes with an investigation, based on Actuaries Investment Index data, showing the comparative results of purchasing shares carrying low, medium or high dividend yields. For the period 1950 to 1955, the advantage appeared to lie with that group of shares providing the lowest dividend yield (but presumably affording exceptional earnings or growth prospects). The construction and maintenance of Index Numbers are discussed in detail in Part IV. This Part deals with the initial selection of the securities, the methods of weighting, averaging and grouping, together with the procedure for keeping the Index up to date. For this purpose, the methods used by the Actuaries Index are compared with the corresponding procedures employed for the Share Index of the London and Cambridge Economic Service. The authors' conclusions regarding Investment Policy are discussed in Part V. Their main points are:— (1) For the Institutional investor, interested largely in income, a well spread and managed ordinary share portfolio should produce over the long-term a much higher return than fixed interest investments. (2) To build up and maintain such a share portfolio to the best advantage, an active policy should be pursued, keeping the “expected yield” as high as possible. For this purpose, the Actuaries Industrial Group Index Tables should be of use, to keep the maximum interest in the more progressive industries, and to reduce participation in the declining trades.