Asset AllocatorMar 4 2021

Will low rates finally spell low returns for DFMs? Wealth firms await next capital gains test

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Running out of road

With quickfire market moves prone to capturing investors’ attention, it can sometimes be tough for even the most stoic allocator to keep their mind on the long term. But for those who want them, there are still plenty of longer-term analyses out there – like Credit Suisse’s annual global investment returns yearbook.

Published today, the report – as usual – begins with “a historical perspective on the evolution of equity and sovereign debt markets over the last 121 years”. There are some forward-looking analyses, too. Chief among them, this year, is a consideration of how the typical balanced portfolio might fare in future.

Of course, predictions are often a thankless task. But they do sometimes create the opportunity to be pleasantly surprised. For a long time now, wealth managers have told clients we are living in a low-return world - yet returns in recent times have remained remarkably strong, all told. Credit Suisse has an answer for that, of sorts: when real interest rates are low, expected future returns on risky assets are also lower. But when real rates fall unexpectedly, this provides an immediate boost to asset prices. Essentially, they are in the camp that says policy action has had the effect of bringing forward future returns.

That doesn’t spell especially good news for the coming years, particularly if you consider there’s not much room left for real rates to fall further. To put it in stark terms, the authors expect annualised returns of 3 per cent on equities, -0.5 per cent on bonds, and just 2 per cent for a ‘70/30’ portfolio in future. The latter is a third of that enjoyed by the previous three generations, and sums up the challenges facing all allocators at the moment.

Stay of execution?

Capital gains tax changes failed to make a splash at yesterday’s Budget. But have investors definitively dodged this bullet, or is this only a temporary respite? The question has relevance for allocators themselves.

Were CGT rates to align with income tax, as some had speculated in the run up to yesterday’s event, that might, at the margin, encourage advisers and clients to look again at the type of portfolios they hold. Would those in segregated discretionary portfolios seek the greater safety of unitised offering – in which individual transactions can take place without being subject to CGT? Or would more seek out bespoke arrangements, to be run with a specific client’s CGT preferences in mind?

In the event, no such change to CGT was forthcoming. There is, however, the little matter of ‘tax day’ still to come this month. On March 23rd the Treasury will outline its thinking on a number of other tax matters, doubtless with a view to further changes once the anticipated economic recovery eventually emerges. CGT might be a part of that. The CGT threshold was frozen until 2026 yesterday – ie won’t be raised before that date. Investors will hope this means it won’t be lowered, either. Even so, taxation rates above this level must still be at risk.

It’s not just capital gains reform that allocators will be keeping their eyes on. Aim reforms floated last year could yet re-emerge, too. In terms of long-term implications for portfolios, the 23rd could yet prove a more significant date this month than the 3rd.

Pregnant pause

Some green shoots for UK equity funds: the first net flows in nine months were recorded in February, according to Calastone. A £145m inflow is hardly cause for celebration, but at this point domestic equity providers will take what they can get. A warning sign, however, came at the end of the month: as volatility increased, UK funds were again the biggest fall guys in the equity space when it came to redemptions.

From fund selectors’ perspective, there were other more interesting developments. Bond funds saw net flows of £846m, despite the spike in yields observed over the period. Just as relevant, perhaps, was the fact that turnover in bond funds was the fourth-highest on record. Selectors might not be giving up on the asset class, but plenty are reconsidering how to take exposure here.