Like any industry, the investment profession is full of jargon. But when we casually apply certain descriptors to assets, do people always understand them in the same way?
The terms ‘growth’ and ‘income’ can be especially problematic when describing two major asset classes, Dr Richard Sorrenson, General Manager at The University of Auckland Foundation, argues; not in the least when adding new investments to a portfolio.
For example, Sorrenson pointed to emerging market assets, which are typically classified as growth assets by the industry, yet some of the most well-established strategies consist more than of half government and corporate bonds.
The justification for calling these bonds ‘growth’ assets often comes from their risk profile, yet it can have significant implications for the asset allocation of a fund.
“It got us thinking about why we actually use these two terms?” Sorrenson said during a presentation at the [i3] Portfolio Construction Masterclass in New Zealand last month.
“When we talk about a fixed income asset, which definition are we using? Are we talking about realised cash in the hand for consumption, or the economic (or accounting) definition of income?
He said that the terms imply a certain behaviour from an investment, but that in reality the experience might be very different.
“What is fixed? We start to think about the security: ‘Oh it must be very safe and simple’.”
“But then we look at this extraordinary bull market in bonds since the 1980s and we see that fixed income hasn’t been fixed at all, it has been highly volatile albeit mainly positively so.
“That has been great for investors, but a tremendous amount of return has been an economic one, not due to the fixed interest payments.”
The Australian housing market was going nowhere for 80 years, and yet this is something that we want to call a growth asset
The disparity between what we say and what we mean is made greater because the terms ‘income’ and ‘growth’ also have day-to-day definitions outside the sphere of investments.
“What happens to your child when they grow? They get bigger,” Sorrenson said. “And so there is a natural assumption that every growth asset is going to increase in value.”
Sorrenson then described an index that showed no overall growth in real terms and even a decline in some periods during an 80 year stretch and asked the audience to identify the asset class.
It turned out that the asset class was the Australian housing market, which has been growing rapidly since 1960, but did not grow at all (in real terms, adjusted for house size) from 1880 until 1960.
“The Australian housing market was going nowhere for 80 years, and yet this is something that we want to call a growth asset, right? ‘Growth’ assets can show no growth, or even shrink, for a very long time.”
“What about a value stock compared to a sold-off corporate bond with a poor credit rating? It is not entirely clear to me which of these is ‘growth’ and which is ‘income’.”
“Are we sometimes confusing ourselves and do we need something else for the terms income and growth?” he said.
Sorrenson argued that part of the blame for confusing these terms was due to the marketing of investment products.
“How do you sell someone a volatile asset? Well, you call it a ‘growth’ asset because that sounds more comforting than a ‘risky’ or ‘high volatility’ asset.”
“And how do you get people into the boring ones? Well you call it an ‘income’ asset because we all need ‘income’ to live on.”
“Obviously, I’m not going to change the industry, but these terms can cause confusion. So, mind your language,” he said.
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