IN THIS ISSUE: In Jane Austen’s many novels of reticent love, the only thing more important than social coterie, is money. The gentlemen of Austen’s 18th Century England were of fabulous (and desirable) wealth, but how was this measured? And what does that definition mean for today’s rugged economy? What, really, is wealth? In this issue of Tactics, John Nicola explores Victorian England’s measure of wealth and how it compares to our standards today. The answers may surprise you.
Mr. Darcy, the proud protagonist of Jane Austen’s Pride and Prejudice, was greatly admired for having an income of “10,000 [pounds] per year.” Based on the novel and the films, he certainly seems to have had a nice lifestyle with his London townhouse and huge country estate. But his story begs a couple of questions:
- How much is Mr. Darcy’s £10,000 worth in today’s dollars?
- Why was his wealth described in terms of his cash flow versus his net worth?
The first question can be answered partially from the article “How Wealthy Is Mr. Darcy — Really? ”, written twenty years ago by James Heldman on behalf of the Jane Austen Society: Mr. Darcy’s income would now be about $1,000,000 per year. A healthy income to be sure, but not one that today could afford the army of servants he had along with his great estate and London home. A better measure of his relative income, however, is that it was the equivalent of “300 times the average annual income of a British subject in 1790,” as per Mr. Heldman.Applying that standard to today’s market (300x$40,000), his income would be in the range of $12-million per year.
Also, governments in the 18th century had not yet invented income tax (interesting how we know who invented the light bulb but not who created income tax; seems no one wants the credit – pun not intended). Therefore, one can see how Mr. Darcy was indeed very wealthy and was quite able to handle the costs associated with his lifestyle.
The second question is more difficult to answer, so I’ll take some literary license and assume that people such as Mr. Darcy could not look up the value of their assets on the Internet daily and, as such, defined their wealth by the cash it generated. This they could measure quite easily. At that time, British consols (consolidated annuities which, at the time, represented the consolidated debt of the British government – basically bonds) paid between 3% and 5%, depending on whether Napoleon was acting up or not, and of course there would be rents from his tenants farming his land. Typically, they hoped for a cash yield of about 4-5% on a relatively balanced portfolio. (Amazing how little some things change over the centuries.) So, even then, cash flow was king – or in Mr. Darcy’s case, landed gentry.
Above is an example of a British consol (picture taken from ‘The Ascent of Money’, Niall Ferguson). This one was acquired by Mrs. Anna Hawes in 1796. The annual income was £5 (therefore a 5% yield). She paid £101 for a £100 annuity and by 1815 (prior to Britain’s victory over Napoleon at Waterloo) the price had dropped to less than £60. Nevertheless, she continued to receive her income of £5 per year. Eventually, prices did recover. Consols were perpetual: the government just paid interest on the bonds and never repaid the principal. The idea was to pass these consols on to your progeny. This may sound strange, but one needs to remember that between 1814 and 1914 there was no inflation. Prices in Britain were stable for 100 years.
So why is this in any way important?
A few weeks ago, Cap Gemini (an international consultant group) came out with their annual review of High Net Worth families around the world. These are families who have $1-million or more of investable assets outside of their personal residence. The Cap Gemini report measures wealth by net worth and the value (or, more accurately, the price) of HNW families assets. It does not measure cash flow. So what does the report show?
- The number of HNW families across the globe shrunk by 15% to 8.6 million families from 10.1 million the year before. In Canada, the numbers dropped by 24% to 213,000 families from 281,000
- The wealth of all of these families was reduced almost 20% from $41-trillion to $32.7-trillion
- The number of Ultra-HNW families dropped by an even greater 24.7% last year. These are families with $30-million or more of investable assets.
- Most asset classes lost money and, as you can see from the graph below, the results for equities are absolutely dismal. Global equity markets are now worth a little less than they were in 1999 and overall last year dropped by 50%. With deference to Andy Warhol, perhaps we are all meant to have 15 minutes of wealth instead of fame.
Before we assume all is doom and gloom, we should also look at this additional chart about HNW families which shows how their assets are allocated.
What does this chart show us?
- Equities dropped from 33% of assets to 25% in 2008. Most of this change was as a result of the impact in the drop in equity prices. Interesting to note that a 33% equity position in 2007 is much lower than what is typically recommended in the financial services industry. A typical balanced investor would be expected to have about 60-70% in equities. (Our own equity models have been about 30-35% for the last 10 years.)
- Real estate increased in value even though housing prices dropped and the Dow Jones Global REIT index went from a high of 1574 in February 2007 to 621 in December of 2008 (a 60% drop). Nonetheless, real estate increased as a percentage of assets from 14% to 18%. This makes more sense than it first appears. As last year’s crisis unfolded, investors were eager to get to some level of safety in government bonds and cash. Real estate is relatively illiquid, but REITs are publicly traded. This means that irrational investors (“we are our own worst enemy,” as they say) were selling REITs as the primary method of reducing exposure to real estate. By reasonable definitions, REIT prices around the world were expensive and well above the Net Asset Value (NAV) in February 2007. However, they were well underpriced by the end of 2008 as panic selling had settled in. REITs have not been this cheap in relation to NAV in more than a decade.
To give you some sense about how far irrational investors can take overvaluation to depressed levels consider the charts of Canadian REITs below. They show prices going from 17x cash flow in 2007 to as low as 6x cash flow in March of 2009. Based on estimates from CIBC, that meant that on a valuation basis they also went from a price that was 15% above NAV to 25% below. The cheapest place to buy real estate was in the stock market. During this time frame the cash flow (net rental income was basically unchanged). Investors first bid prices well above intrinsic value and then, in a panic, forced them well below that same value.
If a picture can tell a thousand words, then the chart below is a great example of the difference between the stability of the growing cash flow derived from REITs (and therefore the underlying real estate) when compared to the volatility of the price (which reflects human behaviour and is both manic and depressive).
This same relative stability in cash flow can be observed with equities as well. As our first chart (Market Capitalization by Region) shows, stock prices are the same or a little worse than they were 10 years ago in most major markets. In addition, they have been very volatile; the S&P 500 dropped 45% between 2000 and 2002, and again in 2008. The dividends paid on those same stocks, however, only dropped marginally – by less than 7% between 2000 and 2002, and not at all in 2008. (That said, it is likely they will end up being about 20% lower by the end of 2009.)
Most publicly traded assets are considerably more volatile when it comes to prices than privately owned real estate or businesses.
The previous examples show how the cash flow of an asset and its price (not necessarily its value) part ways. Price is the result of a daily auction where buyers and sellers try and guess the future. Cash flow, on the other hand, is primarily based on the quality of tenants (real estate), the skill of management (stocks) or the strength of the borrower (bonds and mortgages). The investor has a huge impact on price and almost no impact on cash flow.
This is perhaps the primary reason why wealth should first be defined by income (as was the case in Mr. Darcy’s time) and only secondarily by net worth. In the end, if your assets maintain or increase their cash flow, the long- term value will be undiminished and prices will at some time reflect that value.
So even though in 2008 1.5 million families saw their investable assets fall below $1-million by an average drop of 20%, few would have seen any appreciable change in their cash income from these assets.
This recession is the worst since the 1930s and incomes on some assets will drop. In most cases they will recover when the recession is over. History shows, though, that during the last few hundred years, changes in the income generated by most passive assets is far less volatile than price and thus a far better indicator of real wealth.
As Oscar Wilde put it: “It is better to have a permanent income than to be fascinating.”
I’m sure a number of Jane Austen’s literary ladies would agree.