The 2022 pan-asset market rout heralds some slightly good news for next-generation investors, according to the latest Credit Suisse Global Investment Returns Yearbook.
Based on the seminal work of UK researchers, Elroy Dimson, Paul Marsh, Mike Staunton, the long-term asset class study moves the dial for expected returns for the Z Generation (born 1997 to 2012) up a notch in the 2023 edition compared to last year.
Gen Z investors face much lower overall long-term returns from bonds and equities compared to previous generations but the across-the-board market slump in 2022 has lifted the path of future returns a little, the report says.
The most recently labeled generation can now look forward to 3 per cent real returns from a 60/40 balanced portfolio of shares and bonds – a number that progressively decreases over successive population cohorts from the babyboomer high of 5.6 per cent: for Generation Xers the same forecast returns fall to 5.1 per cent followed by 4.7 per cent those in the Millennial camp.
Bond markets inflict most of the damage for Gen Z investors with forecast long-term annual returns for the asset class falling to 1.5 per cent compared to 4.2 per cent in the preceding generation.
After incorporating the 2022 data the “past has become less rosy”, the Yearbook says.
But the sharp decline in asset prices last year likely reduced the odds of a drawn-out period of ultra-low returns (and low projected returns) as markets adjust to rising inflation and higher interest rates.
“The lower asset prices then imply higher expected returns. This is obvious in the bond market where lower prices lead to higher yields. It is equally true in the equity market, with the higher bond yields forming the baseline for future equity, and indeed all asset returns,” the Credit Suisse report says. “We have thus moved from a low-return world to a somewhat higher-return world thanks to the very poor returns in 2022.”
The Dimson et al study – based on data covering 90 markets, some going back 123 years – confirms asset class observations that equities outperform bonds, which in turn beat cash over the long periods of time.
“Equities were the best-performing asset class everywhere,” the paper says. “Furthermore, bonds outperformed bills in every country except Portugal. This overall pattern, of equities outperforming bonds and bonds beating bills, is what we would expect over the long haul since equities are riskier than bonds, while bonds are riskier than cash.”
However, the long-run logic of markets plays out against different economic cycles where bonds and shares can move in mysterious ways, confounding investor expectations based on recent experience.
Even long-standing ‘golden ages’ for financial assets – such as the 40-year magic run for bonds dating back to the 1988s – come to an end.
“Golden ages, by definition, are exceptions,” the study says. “To understand risk and return in capital markets – a key objective of the Yearbook – we must examine periods much longer than 20 or even 40 years. This is because stocks and bonds are volatile, with major variation in year-to-year returns. We need very long time series to support inferences about investment returns.”
Richard Kersley, Credit Suisse head of global product management, says in the report that last year many investors were caught by surprise as both bonds and equities dived.
“The recent fortunes of 60/40 equity/bond strategies are a painful example of this, having trusted too heavily in the recent negative correlations between the two assets rather than properly consulting the history books,” Kersley says.
And with rising inflation and interest rates testing long-held asset class assumptions, investors may have to adjust diversification strategies in concert.
Despite offering the best prospect of generating higher long-term returns, he says equities “are not and never have been the hedge against inflation that many observers have suggested”.
The Credit Suisse analysis suggests that commodity futures, in fact, are “ almost unique” in providing an “effective hedge against inflation”.
“A key conclusion to take away, and highly pertinent today as 60/40 equity/bond strategies have let investors down, is that commodity futures do prove a ‘diversifier’ from an asset-allocation perspective, being negatively correlated with bonds, lowly correlated with equities and also statistically a hedge against inflation itself,” Kersley says.
Aside from having to weather potentially long drawdown periods during low inflation eras, investors looking for diversification in commodity futures face another dilemma.
“There is a problem, however, with this otherwise attractive asset class,” the report says. “The investable market size is quite small. Thus, while individual investors or institutions may wish to consider increasing their exposure to commodity futures, large increases would be challenging if everyone sought to raise their allocations.”
Dimson, Marsh and Staunton have published the annual asset class analysis since 2002 with Credit Suisse sponsoring the influential report for the last 15 years.