Singapore-based Multi Asset Solutions Senior Portfolio Manager Jan Baars looks at investors’ perception of luck, expected returns and whether it pays to take an active role in controlling your own investment destiny in Australia.
Australia, the ‘lucky country’ certainly has had its share of good fortune over the past 26 years, recently eclipsing the previous record for the longest time without a ‘technical’ recession. Destiny seems to have followed me as I am a native to the previous record holder – the Netherlands – whose 103 quarter winning streak started in 1982 and only succumbed to the turmoil of the Global Financial Crisis in 2008. But being Dutch, meticulous planning, research, and analysis is at the core of our beliefs, as opposed to luck, karma, providence…or whatever word you prefer to use to explain randomness. As it relates to both economic and investment performance, the role of luck tends to be underestimated in the short term and overestimated in the long term.
The Yin and Yang of financial markets
What goes up, must come down, particularly for those praying to the lord of mean reversion. It is somewhat of a paradox that Australians seem to be both cognizant of their good fortunate and acutely aware that their luck may be running out. This is more the case across financial markets, which have seen a near uninterrupted bull market since the post-GFC recovery began in 2009. As Fed Chair Janet Yellen famously said in 2015, “I think it’s a myth that expansions die of old age.” This may be true for economic performance but what about market performance?
Expected returns are very low
While opinions vary considerably with respect to the short term direction of markets, as both an academic and long-time practitioner of asset allocation, there is something I agree with many on: expected returns are very low. And return expectations are very low for nearly every asset class and category. My discussions with Australians have zeroed in on this conundrum. This is mostly a longer term issue as we all know markets can perform wildly different to our expectations in the shorter term. But in the short term we have the following to contend with:
- Low expected returns are driven by low yields and below trend economic growth in developed countries.
- Within Fixed Income there is still some rationale for High Yield and Emerging Markets Debt although not as much as historically as downside risks have increased for credit relative to the potential rewards.
- Tighter policies have been indicated by central banks in the near term.
- Ongoing political uncertainty, with less trust in politicians.
With these headwinds, the most common question I have fielded in my travels has been, “What now?” My answer and the ensuing conversation typically has two parts:
- Expect lower returns
There’s not much we can do about this one except to say that adding risk to deliver to a particular return hurdle is a fine strategy as long as you understand that you are ADDING RISK. Also, given the suppressed volatility of markets, typically Gaussian measure of risk (standard deviation, VaR, etc) are likely underestimating the true risk in your portfolio. Our Multi-Asset Real Return Fund for example remains defensive, holding its lowest allocation to equities since inception nearly 5 years ago and recently reduced credit exposures.
- Seek uncorrelated alpha in your portfolio
Based on our assumptions for the economic climate, and our expected returns, we can determine the likelihood of meeting the portfolio’s investment objective over the investment horizon. It is becoming increasingly likely that relying solely on market beta will not be sufficient to meet return objectives. This is where we recommend to add our dynamic asset allocation process to take into account shorter-term market dynamics to deliver additional returns and abate portfolio risks, such as tail events. By adding an uncorrelated return source (alpha) we can improve the portfolio’s likelihood of meeting the investment objective.
In other words, be realistic and take an active role in controlling your own investment destiny – because the next great opportunity may be right around the corner; you just sometimes need to make your own luck in the meantime.
This material has been prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (Author). The Author forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for the Author is available from First Sentier Investors on its website.
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