New Statesman: The business: economists have discovered that we have been misallocating capital for

Very occasionally, along comes some economic research that leaves you astounded. The London Business School has just come up with a study that a) is intriguing in an anoraky sort of way, b) could possibly make you a lot of money, and c) perhaps even explains something quite profound about being human.

The economists have tracked British stock-market returns over 105 years and discovered a curious and persistent trend. Investors who bought high-yielding shares over the course of more than a century would have become much richer than those buying low-yielding shares.

So what, you may say. High-yielding shares--those paying bigger dividends as a proportion of the share price--would obviously produce bigger returns. Not so, according to classical economic theory. All shares at any time have an identical anticipated percentage total return when discounted back to the present day. Low-yielders--which are usually companies seen as having more exciting growth prospects--are simply expected to produce more through capital gain (the increase in the price of the share itself) and less through immediate dividends.

Yet the anomaly persists, and has done for more than a century--in times of recession, in times of boom, in times of high inflation and in times of stable prices. Sometimes the trend disappears for a few years, as it did in the 1990s, but always it seems to return.

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A sum of [pounds sterling]100 invested in high-yielders in 1900--with the portfolio adjusted once a year--would have grown, with all dividends reinvested, and assuming no transaction costs and no taxes, to [pounds sterling]6.9m by 2005. The same sum invested across the share market as a whole would have produced [pounds sterling]1.5m. Put into low-yielders, it would have grown to just [pounds sterling]296,000. The numbers are much smaller after adjusting for inflation, but the differential--a factor of 23--is just as pronounced.

In essence, high-yielders have produced a return 3.3 per cent a year higher, on average, than low-yielders. Shove in the miracle of compound interest and it makes an extraordinary difference to the investor's great-great-grandchildren.

It is all very curious. It's a bit like discovering a system to beat the house at roulette. It shouldn't persist. The City employs thousands of expert fund managers who have access to all the numbers. Once the trend was spotted--and it was first remarked upon decades ago--the smart money should have moved to exploit it, prices should have adjusted, and the anomaly should have disappeared. It reminds me of the economics professors walking across a Cambridge quad. "Look," says one, "there's a tenner lying on the grass." "It can't be," says the other. "Someone would have picked it up by now."

The point is, information isn't perfect. Markets are inefficient. Anomalies do exist. Sometimes there really is free money to be scooped off the ground. Man Group, the investment house (and sponsor of the Booker Prize), has grown from a tiny sugar-trading company to a [pounds sterling]4bn giant in ten years by embracing this idea. It's called black-box investing. It examines past price patterns to predict prices and places bets accordingly.

Most financial-market anomalies don't last for long. Once a trend is spotted, either it proves to be bogus (some of the brainiest investors are suckers for seeing patterns in what turns out to be randomness) or the weight of money chasing the anomaly forces prices to adjust and the potential profit to vanish.

So how could the high yield/low yield enigma have persisted since the end of Queen Victoria's reign? It's nothing to do with survivorship bias--that tendency for companies to go bust and so, sometimes very conveniently, drop out of the statistics.

Professor Paul Marsh of the LBS has two explanations, neither of them terribly satisfactory. One is that some high-yield companies are only high-yielding because they are close to failing, and that therefore investors demand a disproportionate premium for the risk.

The other is that we are hard-wired to be irrational. Something in the human brain encourages us to ignore decades of historic evidence and plump again and again for shares with seemingly high growth prospects--railway stocks in Edwardian times, radio shares in the 1930s and dotcoms in our own time. Something in our brains or in the water makes us incurable optimists. We prefer to buy shares in capital-hungry, loss-making firms with big ideas and bold visions. And we tend to shun boring, established companies with reliable dividends and unexciting prospects. That willingness to bankroll daring schemes has probably given us all kinds of projects and inventions that, by all rational laws, should never have been financed--the Channel Tunnel, say, and numberless biotechnology companies.

Nevertheless, it seems that private sector capital has been misallocated on a gargantuan scale. And the nation's pensions and long-term savings would have been substantially larger if we could have rid ourselves of this irrational urge.

Patrick Hosking is investment editor of the Times