View from City Road: Five years later, shares hang on

THE SHOCK of having to bicycle to work five years ago yesterday was enough for me. It was the first time I had used a bike in 10 years so, what with the strong wind, fallen trees, and other unsteady cyclists, I had a tricky time getting to work. There was worse to come.

The great storm meant few people made it to the City on Friday 16 October. Those who did found the Stock Exchange computers were down. So dealers worked blind, aware that shares were going down, but not clear by how much. On Wall Street share prices fell by more than 108 points, which was then a record one-day fall.

By the time the computers came up, London share prices had fallen by 137 points. The next week they would slide further.

After a weekend of clearing up broken branches, repairing fences and sweeping leaves, investors went to work, ready to sell. And sell they did. The FT-SE 100 fell by 508 points or 23 per cent on Monday, and kept falling, closing on Friday 28 per cent lower than it was six trading days earlier.

Just as the countryside in the South-east has yet to recover fully from the great storm, so investors' confidence in the stock market has yet to return.

Five years later private investors continue to sell shares - UBS Phillips & Drew estimates that they realised up to pounds 4.6bn from disposals last year and will sell up to pounds 6.5bn this. As a result, they now own only 19 per cent of the stock market against 21 per cent in 1989 and 28 per cent eight years earlier.

After the experience of the crash why does anyone buy shares? At first sight the answer is obvious - investors soon got their money back again and more. The ups more than offset the downs.

But is this true? A closer look shows the risk of being wiped out is hard to justify by the gains seen since 1987. Anyone who spent pounds 10,000 on shares the day before the crash and left it in place would now be left with only pounds 8,800 in real terms. Anyone who put the money in an ordinary building society account instead would have pounds 9,378 today - better off, without taking any risks.

A far better course of action would have been to put the same sum of money into gilts. Anyone who did this five years ago would now have pounds 12,600. All these figures assume dividends and interest were reinvested and have been adjusted for inflation.

Of course, anyone who invested in shares just before the crash would have been very unlucky. A number of brave investors took the plunge shortly afterwards, reckoning prices would bounce back. They were right, although it took two years for the FTA All- Share index to return to pre-crash levels. Anyone who bought a basket of shares in mid-November 1987, a month after the crash, for pounds 10,000 would now have a portfolio worth pounds 12,200. Gilts would have provided pounds 12,000 but a building society would still have left you with less than you started with in real terms.

The outcome suggests that plucky investors were well rewarded. But with hindsight it is obvious that it was not worth taking the extra risk of buying shares instead of gilts for the extra pounds 2,000. After all, companies go bust, but the same cannot be said of the UK government, despite its current difficulties.

If buying shares was simply a matter of diving in after a crash and selling out a few years later, making money would be simple. But lots of people - including fund managers, who invest pounds 350bn on behalf of pension fund members - buy shares at other times.

Pension funds were generally thought to be safety-conscious, at least until Robert Maxwell spoiled their reputation. But they have held about 80 per cent of their money in shares for many years. The current proportion is 82 per cent. Why do they take this risk?

Pension funds are long-term investors, set up to provide pensions for employees who will retire many years from now. While the recent performance of UK shares has been unimpressive, they have easily outperformed gilts over a longer period. And both have produced far better returns than building societies.

A hundred pounds put in the stock market at the end of the Second World War would have been worth pounds 687 in real terms by the end of last year. The same amount put in a building society in 1945 would have been worth just pounds 51. Gilts would have fared little better, producing just pounds 66.

Pensions rise with earnings, so a pension fund manager has to be sure that the portfolio rises in value at least in line with average wages. Over the long run, shares have more than kept pace with earnings, unlike most other forms of investment.

Pension funds are so big that they can spread their investments - holding shares in several hundred UK companies and the same number of overseas ones. This way they can minimise the damage of any one company going bust.

Before Wobbly Wednesday there was a lot of talk among large investors about switching money from shares to gilts because they thought gilts would outperform if inflation continued to fall. Now, however, that talk has subsided, helped by yesterday's cut in interest rates.

Few large investors are confident of a short-term bounce in share prices but they remain confident that shares will reward them well in the medium term. If they are wrong, they will be wrong together.

(Photograph omitted)