David Neal, CEO of Australia’s $117 billion sovereign wealth fund, gave a speech at the Australian British Chamber of Commerce yesterday. He outlined why the Future Fund, as it is known, prefers to invest mostly offshore.
But he also gave a really clear outline – in just one sentence – why asset returns in the years ahead are likely to be substantially lower than they’ve been over the past few years.
Since 2008 we have seen unprecedented action by central banks and governments to defend economic growth through quantitative easing and other policies which have had the effect of driving yields down and asset prices up.
For investors this has boosted returns over recent years, but has done so essentially by bringing forward returns from the future. Our portfolio has generated a 52% cumulative return in less than 3 years since June 2012. These levels of return are not sustainable indefinitely.
That’s right, Neal is saying that the central bank induced returns of recent years have pulled forward earnings from the future.
He added that the dilemma for investors is that central banks have rates at super-low levels to try to induce investors to move out the risk curve “taking more and more risk to stretch for higher returns.” This, he said, was because central banks believe that this will “help kic start animal spirits and increase economic activity.”
But, the problem that arises is that:
The issue for the investor of course is that if you think these long-term returns are not normal, then once the central bank music stops, you might expect that markets will reprice to restore more normal levels of return. This repricing would be painful, and especially so if you have a moved out along the risk curve.
At the very least, the outlook, as Neal says, is for lower returns in the future. That means that Australia’s Future Fund has reduced risk in the portfolio and is currently more “inclined to reduce risk than to chase return” although it’s tempered by policymakers determined to pump up asset prices.
What Neal highlights also builds toward the emerging hypothesis that with a more uncertain investment horizon a crash is coming, and it may be terrific.