Only a decade ago the basic concept of a multi-asset proposition was dramatically different than it is today. It used to basically be a straightforward decision between stocks and bonds. How much did you hold of each asset class as a reflection of your macro view?
We’ve moved light years beyond this conversation.
Now it is all about managing an increasingly multi-dimensional and much expanded opportunity set. And importantly, it is about acknowledging the new norm of lower return markets we face – the likely reality is that simple balanced investing in traditional asset classes is not going to deliver what it once might have for investors.
And that is going to weigh on investment returns. We are investing in a world where effectively “6 per cent is the new 8 per cent”, meaning that investors are going to have to lower their return expectations.
There are four drivers presenting structural challenges driving this trend to lower returns, namely demographics, deleveraging, divergence and directives.
Demographics: Across the developed world, the fall in working age populations is creating a major economic headwind. Globally, sluggish labour force growth and an ageing population are putting a speed limit on growth, implying lower nominal and real interest rates ahead. The relative bright spot is the US, where population growth remains positive, but only just.
Deleveraging: Post the great financial crisis, private sector debt burdens have shifted to the public sector. As a result, attention has been focused on the need to reduce debt-to-GDP levels, leading to fiscal austerity which has restrained growth. Meanwhile, although the financial sector has largely deleveraged, other segments have not and debt levels have risen above 200 per cent of GDP globally.
Divergence: Differences in the direction of travel in monetary policy (i.e. the US Federal Reserve tightening with their counterparts such as the Bank of Japan easing) engenders fragility and dents confidence. For example, excessive policy divergence was, in part, a driver of tighter financial conditions early in 2016, which contributed to market turmoil. Market sentiment is now hypersensitive to policy tightening, creating a damaging feedback loop.
Directives: This can function as a constraint on credit formation, holding back growth. In many ways, increased regulation following the financial crisis has been needed and welcome, but it has not come without economic implications. Thus far, the clearest consequences can be seen in the financial sector, where the impact has been slower lending and lower earnings for financials.
These macro factors in combination have significant implications for policy rate normalisation and the degree to which it will (not) be accompanied by higher bond yields. The process of markets trying to work this out has already begun. What was a period of relatively easy post-crisis years for balanced investors, in which markets were virtually universally carried upwards by a sea of abundant liquidity from central banks, have given way to dicier conditions as investors start to reprice liquidity.