The next decade is going to be lousy for investors.
Jonathan Wilmot, head of macroeconomic research at Credit Suisse Asset Management, compared the present day environment to the aftermath of the Latin America debt crisis, the 1930s Great Depression and the 2008 Great Recession.
Here’s the upshot: after an initial multi-year recovery in stock and bond prices after a crisis (the rally we saw through last year), comes a long stretch of lousy returns.
That is going to be “disastrous” for savers, and poses a serious threat to the fund management industry.
Consider this a part of ‘The easy money has been made’ meme.
A key factor is that financial shocks lead to secular reflation, which is to say that governments typically embark on inflationary measures such as public spending to stimulate the economy. Here is Wilmot with an explanation of what that means.
By secular reflation, we mean at least a decade in which short- and long-term interest rates stay habitually below nominal GDP growth and high grade bonds are not really bonds any more: delivering trend returns that are close to zero or even negative.
Reflation is essentially a structural subsidy from savers to borrowers, and normally favours equities over bonds. After both previous major crises — when private and public debt levels were relatively high — slower debt growth, selective debt re-structuring and a long period of reflation have been the solution.
Given current demographics, one can probably add to that various types of soft default as governments gradually renege on some of their healthcare and retirement promises.
History shows that the first seven to eight years following a crisis (think 2008 to 2016 in this case) tend to deliver above average returns for bonds and stocks, according to the report. Equities sink to a low at the height of the crisis and then recover, and bond yields trend down as central banks look to stimulate the economy.
“Investment in these circumstances needs to be little more than efficient diversification,” Wilmot said.
A different world
Those days are over. Returns tend to be much lower over the decade that follows the runup.
- From 1900 to 1910, real bond returns stood at -1% per annum, and 6% per annum for real equity returns
- From 1939 to 1949, real returns were 2% per annum for bonds, and 3% for equities.
That would suggest zero real returns on bonds and 4% to 6% returns on equities. That would mean a typical mixed portfolio of stocks and bonds would deliver a 1% to 3% per annum return, down from around 10% over the past seven years.
This is not an attractive prospect for savers, or fund managers. Efficient diversification will not be enough to earn good returns; even very well established track records will provide a less reliable guide to future performance; and bond managers will probably have to stray far from their comfort zone to deliver even modestly positive real returns.
For savers, particularly retiring baby boomers, ultra-low yields are little short of disastrous, especially given that a 100% allocation to bonds or annuities is the default option for retirees. More generally, the prospect of a decade or more of zero real returns on “safe” bonds poses a huge structural challenge to the fund management industry. Up until now, the investor response has been to move up the risk spectrum within fixed income, by increasing exposure to riskier credit and more illiquid investments, but this approach may be nearing its limits.
Wilmot runs through a bunch of investment strategies that might see renewed interest in light of these financial conditions, ranging from equity funds which offer some sort of hedge against volatility to big-data driven quant funds. He also mentions risk premia investing, an investment strategy that focuses on risks (like volatility or momentum) as opposed to asset classes (like stocks or bonds).
“Paradoxically, as the fashion for passive investing sweeps the world, the potential benefits of high quality active investment are about to increase enormously,” he said.
Of course someone who has an interest in promoting active management is going to say that.
On the other hand, given the potential market performance over the next decade, maybe he has a point.
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