Boston Global Market Commentary: Investment Outlook and Implications for Risk-Adjusted Returns
With historically low interest rates and volatile global markets , investors are likely to be in for a period of long-term average returns in the low to mid-single digits. This applies to the traditional sectors of equities, fixed interest, and real estate.
What does that mean for Risk-Adjusted Returns?
Does a lower return outlook mean that we are receiving these returns for a lower level of risk, or will the risk / return trade-off change so that we are getting lower returns for the same or higher level of risk?
Looking at the past 40 years we have seen the Australian 10-year bond rate fall from over 15% pa to around 1% pa today. During this period where long term rates fell, investors got a "free kick" in terms of their returns as capital values increased as:
equities generally increased in value with higher PE ratios
bonds naturally increased in value with lower interest rates; and
real estate values increased with falling discount rates and cap rates.
An interesting observation is if you apply PE Ratio logic to say 10-year bonds, we have gone from a PE of 6.67 times, to 100 times. Clearly, the cost of buying future income is getting very expensive!
Today, this "free kick" is nearly all but gone, so the future will have some payback as interest rates rise. Whilst we don't know if rates will start rising next year or in 20 years' time, one can be confident that at some point they will increase to a more historically normalised level.
This period of "different risk" should increase the risk of all asset classes, in terms of variability of return, income risk and capital risk. This risk is likely to be “unrewarded” in the traditional sense, so it is likely that we will be seeing lower returns in the future, for similar, or arguably greater, levels of risk.
Investment strategies will need to re-think their asset-liability matching strategies going forward, and it is likely that new investment approaches will need to be followed to ensure that acceptable outcomes are delivered to investors.
This document has been prepared by Boston Global. Documents published on this website are for general information only and are not intended to provide you with personal financial advice as we do not take into account your personal objectives, financial situation or needs. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Replication of this information requires prior approval and appropriate referencing to the entire document.