How to supercharge your investments in a low-return world
The investment environment hasn’t changed much since January 2010. Peter Brooke, Boutique Head, Macro Strategy Investments (MSI) planted a “not much has changed” stamp over the investment outlook slide in his 27 July media presentation titled: Asset allocation – Distinguishing true themes from the noise. He set about identifying the five major investment trends that will dominate fund managers’ decision making over the next five to 10 years. In today’s newsletter we’ll touch on each of these themes and identify ways to manage money successfully in a low-return environment.
A handful of new investment trends
The first trend dominating the investment world, says Brookes, is big government. It’s a theory built around the effect of spiralling debt on government – and the impact to the economy of the fiscal policies governments are introducing to combat it. The US National Debt is ticking higher to the tune of $1bn each day and US government debt as a percentage of GDP will reach WWII levels in a matter of months. “As soon as you get beyond 70% you’re in trouble,” says Brookes. Developed countries are being forced to implement policy decisions that will fundamentally impact on equity market returns and currencies.
We’ve already seen this ‘debt effect’ on the US dollar (a couple of years ago) and Euro (this year). Next year the Yen could be in crisis. If you look at the debt levels in developed countries it’s clear 2008 is a developed world crisis! Their emerging world peers are generally running debt levels well below 70% of GDP. Big government is going to negatively impact bond markets, currency markets and economic growth. “Governments’ hands are increasingly tied when it comes to stimulating growth through fiscal intervention,” notes Brookes. As these ‘bail-outs’ dry up companies struggle to make profit and various statistical measures of recovery falter. That’s why MSI prefers inflation protected assets on a five to 10-year view.
Trend number two is aptly referred to as cash is trash! Cash returns in developed economies are trending to zero, or as close to zero as makes no difference. “Cash has become trash all over the world,” says Brookes, jokingly referring to the ‘Japanification’ of interest rates. MSI is steering clear of global cash and reckons South African investors won’t be spared for much longer. The nominal return on cash held in domestic bank deposits is already at 6.5%. When cash returns are close to zero, says Brookes, money goes in search of return. And this causes bubbles!
A golden era for the developing world...
The next bubble could well come from emerging markets – our third trend. If you lump together countries like the BRICs (Brazil, Russia, India and China) and the so-called ‘next 11’ you’re talking about 85% of the world’s population, 70% of its land mass, 70% of global Forex reserves and approximately 40% of GDP! That’s a perfect recipe for continued economic growth. Brookes says one of their aggressive funds is already one third invested in emerging markets, primarily Asia.
The question is whether it’s possible for a bubble to form in emerging equity markets given their current ‘steep’ valuations? Brookes reckons the emerging market performance since 1997 represents a normalisation of values, with the bubble still to come. Says Brookes: “When I look at a stock like MTN with all its exposure to Africa it’s a no-brainer.” The company is perfectly poised to harvest the emerging market sub-theme!
Fund managers are investing in a low-return world – the fourth theme. At 1 July 2010 MSI predicts five-year real returns on international equity at 7%, with 1% from international bonds and nothing from cash! South African investors aren’t going to do much better, with 6.5% from equities, 6% from property and 3% and 2.5% from bonds and cash respectively. Fund managers and private investors alike must take cognisance of this low-return environment. The oft promised 7% real return is going to require 100% equity exposure plus a liberal splash of luck. Savers and financial planners need to revise their expectations down. And they’re going to have to get used to the idea of supplementing return by saving more or spending less.
Keeping the rand strong
The fifth theme is a continued rush to yield! Developed economy fund managers are sharpening their spears and expanding their territories in the hunt for post-recession yield. They know it’s not on offer in their own back yard. “It’s no surprise the rand has been strong and manufacturers are crying – we have yield – and people are prepared to buy yield even if there’s risk in it,” says Brookes. Foreign fund inflows to the South African bond market topped R50bn in the year to 30 June 2010 – keeping the rand strong against the US dollar, Euro and British pound.
There’s yield on offer in equities too. A unique situation is developing in the UK and Japanese equity markets – and to a lesser extent in South Africa – where dividend yields are outstripping bond yields. MSI is chasing dividends in South Africa and has added companies such as Metropolitan, Nampak and Foschini to their portfolios. British American Tobacco with its 5% per annum Sterling dividend is an increasingly important portfolio constituent.
Editor’s thoughts: There you have it! The 26% nominal return from local equities in 2009 was a fluke – you can expect much lower real annual returns from shares until at least 2014. With the yield on offer from bonds and cash looking unattractive the emphasis will have to be on savings fundamentals. Do you possess the discipline required to invest in a low-return world? Add your comment below, or send it to [email protected]
