No SSB, BGI trading pact
We would like to set the record straight about the issues covered in your page 2 story in the April 30 issue ("Under pressure, SSB reins in global indexing group").
No letter was ever sent by Ms. Dunn or anyone at BGI to Mr. Carpenter or anyone at SSB complaining about SSB "sales tactics" (or any other subject).
SSB's decisions about how to organize its index research business have been entirely its own without involvement from BGI, much less "pressure."
No pre-commitments to trade MSCI index changes or any other trades have ever been made by BGI to SSB.
SSB acknowledges that BGI's trading with SSB has always been based on best execution.
We welcome the continued debate and disagreement on the substance of the upcoming MSCI Index changes.
chairman and chief executive officer
Salomon Smith Barney
Patricia C. Dunn
global chief executive
Barclays Global Investors
`Death of the risk premium' redux
The critique by Chester Schneider of our work on "the death of the risk premium" is an example of the popular mistake of forecasting the future by extrapolating the past (Other Views, March 5). Real earnings growth of 5% and real returns of 7.5% from current market levels? Gosh, Toto, if we can just believe and click our ruby slippers, we can be magically transported back to Kansas, and earn double-digit returns forever when we get there!
The flaws in this superficial analysis are numerous. The best way to illustrate the problem is to point out that Mr. Schneider's methodology would point to a positive risk premium if stocks were infinitely expensive. Far too many people in our industry believe that, because long-term investors have "always" been rewarded with an equity risk premium, they must always be rewarded with an equity risk premium. Far too few people even consider the question, "is there some price level at which the risk premium will disappear?" Even casual thought about this question leads to a fundamental rethink of the nature of the equity risk premium, a dialogue that Ron Ryan and I are pleased to have contributed to.
Other problems in Mr. Schneider's piece are numerous. Counting the stock buybacks in cash flow and in increased future earnings per share growth is double counting.
It's interesting to note that in the year since Ron and I wrote "Death of the Risk Premium," U.S. stocks have underperformed U.S. bonds by well over 2,000 basis points. When people die, they don't come back! When the equity risk premium dies, it can and should come back, for the simple reason that equities are riskier than bonds and that equities are a secondary claim on financial resources relative to bonds. Both of these arguments should result in a risk premium. However, nowhere is it written that investors always will behave rationally, nor is it provided in contract law that equities shall always produce a risk premium. Finance theory suggests they should, but the simple economics of capital markets' returns means that, at some price level, that risk premium must vanish. In 1999-2000, we believe we exceeded that price level. We believe that, at the market peak, truly heroic assumptions were required to deliver any material equity risk premium for long-term returns.
The problem with the "death of the risk premium" is not so much that equities subsequently return less than bonds. The big problem is that equities naturally should be priced to provide a superior return to bonds. It is the transition from an abnormal condition (a negative risk premium) to a normal condition (a positive risk premium) that is grinding and painful, as we've seen in the past year. A negative risk premium is not without precedent. In 1987, just before the market crash, government bonds briefly reached a 10% yield, in an environment with 3.5% consensus inflation expectation. This 6.5% real yield exceeded anything that could reasonably have been expected from stocks priced at a modest 2.6% yield.
Robert D. Arnott