Chief Economist and Head of the Investment Strategy team
Low and falling investment yields from most major asset classes point to a constrained medium term return outlook. For a diversified mix of assets, this has now fallen to around 6.9% on our projections.
For investors the key is to: have realistic return expectations; allow that inflation is also low so real returns aren’t down as much; focus on asset allocation; and focus on assets with decent & sustainable income.
While the high inflation of the 1970s and early 1980s was bad for investment returns at the time, it left a legacy of very high investment yields which helped set the scene for high investment returns through the 1980s and 1990s. Back in the early 1980s the RBA’s “cash rate” was averaging around 14%, 3 year bank term deposit rates were around 12%, 10 year bond yields were around 13.5%, commercial and residential property yields were running around 8-9% and dividend yields on shares were around 6.5% in Australia and 5% globally. Such yields meant investments were already providing very high cash income. So for assets like property or shares only modest capital growth was necessary to give good returns. As a result, back then the medium term (5-10 year) return potential from investing was solid. In fact most assets had spectacular returns in the 1980s and 1990s. Australian superannuation funds saw returns average 14.1% pa in nominal terms and 9.4% pa in real terms between 1982 and 1999 (after taxes and fees).
# Current dividend yield for shares, distribution/net rental yields for property and duration matched bond yield for bonds. ^ Includes forward points. * With franking credits added in. Source: AMP Capital
Megatrends influencing the growth outlook
Several themes are allowed for in our projections: slower growth in household debt; the backlash against economic rationalist policies of globalisation, deregulation and small government; rising geopolitical tensions; aging and slowing populations; low commodity prices; technological innovation & automation; the Asian ascendancy & China’s growing middle class; rising environmental awareness; & the energy revolution. Most of these are constraining nominal growth and hence investor returns. However, technological innovation is positive for profits and some of these point to inflation bottoming. (See “Megatrends…”, Oliver’s Insights, July 2016.)
Key things to note
Several things are worth noting from these projections.
The medium term return potential using this approach continues to soften largely reflecting the rally in most assets of the last few years which has pushed investment yields lower. Projected returns using this approach for a diversified growth mix of assets has fallen from 10.3% pa at the low point of the GFC in March 2009 to 6.9% now.
Source: AMP Capital
The starting point for returns today is far less favourable than when the last secular bull market in shares and bonds started in 1982, due to much lower yields.
Government bonds offer low return potential thanks to ultra low bond yields.
Unlisted commercial property and infrastructure continue to come out well, reflecting their relatively high yields.
Australian shares stack up well on the basis of yield, but it’s still hard to beat Asian shares for growth potential.
The downside risks to our medium term return projections are referred to endlessly by financial commentators: namely that the world is plunged into another recession or that investment yields are pushed up to more normal levels causing large capital losses. The upside risks are (always) less obvious but could occur if global growth improves but inflation remains low which could see a continuing search for yield further pushing up capital values.
Implications for investors
There are several implications for investors:
First, have reasonable return expectations. The combination of low investment yields & constrained GDP growth indicate it’s not reasonable to expect sustained double digit returns. In fact, the decline in the rolling 10 year moving average of superannuation fund returns (first chart) indicates we have been in a lower return world for many years.
Second, allow that this partly reflects very low inflation. Real returns haven’t fallen as much and are still reasonable.
Third, using a dynamic approach to asset allocation makes sense as a way to enhance returns when the return potential from investment markets is constrained. This is likely to be enhanced by continued bouts of volatility.
Finally, focus on assets providing decent sustainable income as they provide confidence regarding future returns, eg; commercial property and infrastructure.
About the Author
Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.