The NZ equity risk premium relative to bonds and cash (using Treasury bills as proxy) has declined over the last 50 years against the 120-year average, according the just-released Credit Suisse Global Investment Yearbook.
Local shares returned 2.6 per cent above bonds and 3.6 per cent over cash each year on average during 1970 to December 31, 2019: the same figures for the 120-year period come in at 4.1 per cent and 4.7 per cent, respectively.
But shares remain the best bet to maintain portfolio growth despite a declining equity risk premium almost everywhere, the report says.
“Prospectively, the authors estimate that the equity risk premium will be 3½%, a little lower than the historical figure of 4.3%, but still implying that equity investors can expect to double their money relative to short-term government bills over 20 years,” the Credit Suisse study says.
Nonetheless, investors should take a “sober view” on expected excess returns from risk assets in light of the ongoing low interest rate environment.
“The study has shown that, when real rates are low, future returns on equities and bonds tend to be lower rather than higher,” the Credit Suisse report summary says.
Based on research from London Business School and Cambridge University academics Elroy Dimson, Paul Marsh and Mike Staunton, the study found NZ equities in nominal terms returned well above the 120-year average during the first two decades of the 21st century.
According to the Credit Suisse figures, NZ shares delivered annualised returns of almost 8 per cent from 2000 until the end of last year, compared to 5 per cent for local bonds and 2.1 per cent for Treasury bills.
NZ recorded the fourth-best equity market returns over the last 120 years, the research shows.
The in-depth asset class returns study found NZ equities returned an annualised 6.4 per cent since 1900 until the end of last year in local currency terms.
Only the US, South African and Australian share markets have outperformed NZ, the Credit Suisse yearbook says, with the latter turning in the highest 120-year result of 6.8 per cent per annum.
“The Credit Suisse researchers note it is not just due to the ‘luck’ of abundant resources, good weather and distance from geopolitical issues,” the report says. “In fact, services make up three-quarters of Australia’s GDP. The rule of law, a strong education system and established regulatory frameworks means Australia is an attractive destination for foreign investors. Australia also remained relatively insulated from the Global Financial Crisis due to its strong banking and savings system in the form of compulsory superannuation.”
The report also sheds light on the growing influence of factor-investing and environmental, social and governance (ESG) trends – including a potential correlation between the two styles.
The study notes “with alarming circularity, a moot point is whether ESG investing and the weight of flows attracted to it intrinsically carry negative consequences for value when one considers the sectors most likely impacted by exclusions”.
Value has latterly been the worst-performing of the five factors “that have exhibited premiums both over the long-run and across countries”, the report says. Along with value, the research found size, income, momentum and low volatility as persistent factors in equity returns.
“In the USA, value stocks have now underperformed growth stocks over the last 31 years,” the study says.
Factor returns overall, though, have been wobbly during the 12 years following the global financial crisis (GFC), the report notes. In UK and US markets post the GFC only half of the 120 “premiums” delivered by the five factors were positive, according to the Credit Suisse research.
“Looking ahead, while the authors stress the continuing importance of factor effects, they caution that factor premiums are by no means assured,” the report says
Meanwhile, while ESG investing is “re-shaping the nature of asset management”, the study found no conclusive long-term evidence that the approach – now likely influencing about US$40 trillion – leads to better risk-adjusted returns.
“This is in part due to lack of consistent data and universal agreement on what defines E, S and G or perhaps it is a logical reflection of efficient markets,” the report says. “However, neither does there seem to be a high price to be paid for ethical principles.”
The long-running Dimson et al yearbook is considered the most comprehensive review of asset class returns, covering more than 91 per cent of the “investable universe at the start of 2020”.