Expected medium-term returns from diversified portfolios have more than halved compared to the previous five years, according to a new Melville Jessup Weaver (MJW) analysis.
Published last week, the MJW client note shows current projected five-to-seven-year returns on idealised risk-weighted portfolios range from 2 per cent for conservative funds to just 4.5 per cent for growth strategies.
“The gap between what investors have received over the last five years and what we expect for the next five years is stark: the difference for a balanced fund investor is 4.7 percentage points per annum,” the MJW paper says.
Over the last five years, actual long-term performance ranged from 6 per cent for conservative portfolios to 10 per cent at the higher risk end of the spectrum.
But double-digit returns over the next five or so years are probably out of the question even for the most aggressively tilted portfolios.
“While we may be proved wrong and future returns turn out not to be as weak as we fear, it seems unlikely that returns will be nearly as strong as what has been received recently,” the MJW study says.
And the Auckland-based consultancy firm’s forward-looking asset model did under-estimate the strength of real five-to-seven-year returns in the post global financial crisis (GFC) era.
For example, from 2009 to 2015 actual balanced fund performance was consistently above the MJW projections by more than 2 per cent in most years.
“… the balanced fund return from 30 September 2015 was 8.8% pa compared with our more modest outlook of 6.2% pa at the time,” the analysis says.
“It is perhaps fair criticism to say that our investment modelling has been conservative,” the MJW report says. “We did not predict the strength of capital appreciation in either equity or bond markets. However, we are pleased with the review of these results. Our clients have not been in a position of over-promising and under-delivering to their stakeholders.”
Unsurprisingly, the study, authored by MJW principal Ben Trollip, anchors the restrained performance forecasts to persistent low interest rates, which implies, barring more capital gains, “returns will be low”.
Investors will either have to lower expectations or employ a limited palette of strategies to boost returns in the years ahead, including:
- increasing exposure to risky assets;
- hiring active managers looking to outperform benchmarks;
- cutting costs and lifting implementation efficiencies; or,
- investing more in alterative assets.
“However, none of these tactics provides a guarantee of better returns,” the MJW paper says. “At the very least, investors need to communicate the potential for lower returns in the future to their stakeholders. Investors have difficult decisions ahead.”