1. Total Market Return (TMR) – Review of UKRN conclusions, historical trends and forward-looking evidence
Richard Hern
28 February 2019

2. Total Market Return (TMR) proposed in recent regulatory documents have been consistently lower than CMA NIE 2014 decision
Decision
TMR (in RPI terms)
Approach
CMA NIE (2014)
6.5%
Historical DMS returns using different holding periods and estimators
Ofwat’s PR19 (2017)
4.85 – 6.13%
Based on forward-looking evidence and current market evidence
UKRN (2018)
5.0 – 6.0%
Based on historical DMS returns, adjusted downwards to account for predictability of returns
Ofgem RIIO-2 (2018)
5.19 – 5.84%
Based on UKRN report and cross-checked against forward-looking evidence and investment managers’ surveys
Ofcom’s BCMR (2018)
5.8%
Based on historical and forward-looking evidence
CAA’s RP3 (2018)
5-6.25%
Based on historical and forward-looking evidence. Upper bound based on previous regulatory decision (RP2)

3. But has the UK TMR really declined over time
But has the UK TMR really declined over time? Historical data on UK realized returns does not suggest it has

4. Other major global equity markets show no discernible decline in realised returns over the recent period
US equity market returns
Germany equity market returns
Japan equity market returns
France equity market returns

5. Forward Looking data from the Bank of England also shows no evidence that the TMR has declined over the last years (absent “crisis” periods)

6. Bloomberg’s UK Real Market Return Calculated Using the DDM Does Not Show a Declining Trend

7. Even PwC’s own DGM Does Not Show a Declining Trend in the TMR

8. Survey Evidence from Fernandez Does Not Show a Trend Decline in TMR

9. Forward Looking Models used by many UK regulators to justify a lower TMR are using UK GDP forecasts as the basis for estimating investors’ expectations of future earnings. But do investors really base their forecasts of future earnings for FTSE stocks on UK GDP forecasts?
“valuation tests …. offered strong evidence that investors place the greatest weight on forecasts from Institutional Brokers of Analysts” p.95 Patterson, The Cost of Capital.
If the DGM Models are re-estimated using analysts’ forecasts of future earnings, the TMR increases by over 1.5%

10. The UKRN 2018 report advocates using a TMR of 5-6% based on historical returns deflated by a constructed “CPI” series
Historical inflation data labelled as “CPI” by the BoE does not represent a reliable measure of historical CPI.
“The method provides only approximate results and there is no way to determine how accurate our method is as sufficient data to construct CPI do not exist prior to 1987”
For the period , the CPI series used by the BoE/UKRN is the same or higher than RPI!
Period
RPI source
CPI source
RPI-CPI wedge
Official ONS RPI index
Official ONS CPI index
71 bps
Modelled back series of CPI (ONS, 2013)
28 bps
Implied deflator for consumers’ expenditure (O’Donoghue et al., )
0 bps
Implied deflator for consumers’ expenditure (O’Donoghue et.al., )
Cost of living index (Feinstein, 1991)
-30 bps
Conclusion: it is far from clear that the TMR has fallen since the CMA’s estimate of 6.5% in 2014