Follow the lead of Clare College. Smithers & Co pass on the advice they gave to the Cambridge college in their latest report. As you might expect from the upper educational echelons, Clare is somewhat unusual as an investor:
Clare College is in a position to borrow on very favourable terms given its very high level of creditworthiness. It had been offered both nominal and index-linked debt at a modest premium over the yields on UK government debt shown in Table 1. For a given spread over gilts, for reasons outlined in more detail later in this report, we regard the opportunity to borrow in index-linked terms as particularly favourable, and thus focus our detailed analysis on this strategy.
Moreover:
As well as being unusual in terms of creditworthiness, the college had an unusually long-term investment horizon, reflecting its long history, and a commitment to future generations of students into the more or less indefinite future. We were therefore asked to consider the likely risks and returns to this strategy over a very long horizon of 40 years, which was the agreed maturity of the bond.
The upshot from Smithers, with current yields on long-dated bonds well below average historical returns on equities, is that there is a potentially profitable opportunity for investors to borrow and invest the proceeds in stocks. They conclude that funding a UK portfolio by issuing an index-linked bond has a high chance of yielding strong returns over a long-term horizon – despite their house view that the UK equity market is overvalued.
There are certain caveats and conditions. The strategy is not advisable over a shorter timeframe. An investor’s current wealth position should be strong enough to take the downside risks and to borrow on favourable terms.
In other words, if you do not share many characteristics with the spectacular building on the Backs, then you probably shouldn’t be borrowing to invest in UK equities.
Update