Past Decade of strong returns unlikely to be repeated

The current return assumption for the average US public pension fund is 7.25%, according to the National Association of State Retirement Administrators (NASRA), highlighted in a recent CFA Institute Blog: Global Pension Funds the Coming Storm.

This compares to the CFA Institute’s (CFA) article expected return for a Balanced Portfolio of 3.1% over the next 10 years.  A Balanced Portfolio is defined as 60% Equities and 40% Fixed Income.

Therefore, the article concludes that a 7.25% return assumption is “overly optimistic in a low return interest rate environment”.

The expected low return environment will place increasing pressure on growing pension liabilities and funding deficits. This is over and above the pressures of an aging population and the shift toward Defined Contribution (DC) superannuation schemes e.g. KiwiSaver.

This environment will likely require a different approach to the traditional portfolio in meeting the growing liabilities of Define Benefit (DB) Plans and in meeting investment return objectives for DC superannuation Funds such as KiwiSaver in New Zealand.

The value will be in identifying and implementing the appropriate underlying investment strategies.

 

Past Returns

For comparison purposes an International Balanced Portfolio, as defined above, has returned around 7.8% over the last 10 years, based on international fixed income and global sharemarket indices.

A New Zealand Balanced Portfolio has returned 10.3%, based on NZ capital market indices only.

New Zealand has had one of the best performing sharemarkets in the world over the last 10 years, returning 13.5% per annum (p.a.), this compares to the US +11.3% p.a. and China -0.7% p.a.. Collectively, global sharemarkets returned 10.2% p.a. in the 2010s.

Similarly, the NZ fixed income markets, Government Bonds, returned 5.4% p.a. last decade. The NZ 5-year Government Bond fell 4.1% over the 10-year period, boosting the returns from fixed income. Interestingly, the US 5-year Bond is only 1% lower compared to what it was at the beginning of 2010.

 

It is worth noting that the US economy has not experienced a recession for over ten years and the last decade was the only decade in which the US sharemarket has not experienced a 20% or more decline. How good the last decade has been for the US sharemarket was covered in a previous Post.

 

In New Zealand, as with the rest of the world, a Balanced Portfolio has served investors well over the last ten or more years. This reflects the strong returns from both components of the portfolio, but more particularly, the fixed income component has benefited from the continue decline in interest rates over the last 30 years to historically low levels (5000 year lows on some measures!).

 

Future Return Expectations

Future returns from fixed income are unlikely to be as strong as experienced over the last decade. New Zealand interest rates are unlikely to fall another 4% over the next 10-years!

Likewise, returns from equities may struggle to deliver the same level of returns as generated over the last 10-years. Particularly the US and New Zealand, which on several measures look expensive. As a result, lower expected returns should be expected.

The lower expected return environment is highlighted in the CFA article, they provide market forecasts and consensus return expectations for a number of asset classes.

 

As the article rightly points out, one of the best estimates of future returns from fixed income is the current interest rate.

As the graph below from the article highlights, “the starting bond yield largely determines the nominal total return over the next decade. So what you see is what you get.”

 

US Bond Returns vs. US Starting Bond Yields

US Bond Returns vs US Starting Bond Yields

 

In fact, this relation has a score of 97% out of 100%, it is a pretty good predictor.

The current NZ 10 Government Bond yield is ~1.65%, the US 10-Year ~1.90%.

 

Predicting returns from equity markets is more difficult and comes with far less predictability.

Albeit, the article concludes “low returns for US equities over the next 10 years.”

 

Expected Returns from a Balanced Portfolio

The CFA Article determines the future returns from a Balance Portfolio “By combining the expected returns from equities and bonds based on historical data, we can create a return matrix for a traditional 60/40 portfolio. Our model anticipates an annualized return of 3.1% for the next 10 years. That is well below the 7.25% assumed rate of return and is awful news for US public pension funds.”

Subsequent 10-Year Annualized Return for Traditional 60/40 Equity/Bond Portfolio

Subsequent 10 years annualized Return for Traditional 60 40 Equity Bond Portfolio.png

 

This is a sobering outlook as we head into the new decade.

Over the last decade portfolio returns have primarily been driven by traditional market returns, equity and fixed income “beta“. This may not be the case when we look back in ten-years’ time.

 

This is a time to be cautious. Portfolio strategy will be important, nevertheless, implementation of the underlying strategies and manager selection will be vitally important, more so than the last decade. The management of portfolio costs will also be an essential consideration.

It is certainly not a set and forget environment. The challenging of current convention will likely not go unrewarded.

Forewarned is forearmed.

 

Global Pension Crisis

The Global Pension crisis is well documented. It has been described as a Financial Climate Crisis, the risks are increasingly with you, the individual, as I covered in a previous Post.

As the CFA article notes, the expected low return environment adds to this crisis, as a result deeper cuts to government pensions and greater increases in the retirement age are likely. This will led to greater in-equality.

 

This is a serious issue for society, luckily there is the investment knowledge available now to help increase the probability of attaining a desired standard of living in retirement.

However, it does require a shift in paradigm and a fresh approach to planning for retirement, but not a radical departure from current thinking and practices.

For those interested, I cover this topic in more depth in my post: Designing a New Retirement System. This post has been the most read Kiwi Investor Blog post. It covers a retirement system framework as proposed by Nobel Laureate Professor Robert Merton in his 2012 article: Funding Retirement: Next Generation Design.

 

Lastly, the above analysis is consistent with recent calls for the Death of the Balanced Portfolio, which I have also Blogged on.

Nevertheless, I think the Balanced Portfolio is being replaced due to the evolution within the wealth management industry globally, which I covered in a previous Post: Evolution within Wealth Management, the death of the Policy Portfolio. This covers the work by the EDHEC-Risk Institute on Goals-Based Investing.

 

In another Posts I have covered consensus expected returns, which are in line with those outlined in the CFA article and a low expected return environment.

In my Post, Investing in a Challenging Investment Environment, suggested changes to current investment approaches are covered.

Finally, Global Economic and Market outlook provides a shorter-to-medium term outlook for those interested.

 

Please note, I do not receive any payment or financial benefit from Kiwi Investor Blog, and a link to my Discloser Statement is provided below.

 

Happy investing.

Please read my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

How good will the next decade be for Investing?

“Adjusted for risk—or, more precisely, the volatility stock investors had to bear—gains in the S&P 500 index since Dec. 31, 2009, are poised to be the highest of any decade since at least the 1950s.” as outlined in a recent Bloomberg article, The Bull Market Almost No One Saw Coming.

Who would had thought that back in 2009?

 

As the Bloomberg article highlights, it has been a relatively smooth ride of late; equity market volatility has fallen in line with the sharp decline in interest rates over the last ten years.

Also assisting the smoother ride in US equity markets has been the lower volatility in US economic activity. The US economy has expanded by 1.6% to 2.9% in each of the previous nine years, a similar level of economic activity is expected in 2019. According to Bloomberg, based on standard deviation, that’s the smallest fluctuation over any 10-year stretch in data going back to 1930.

 

In fact, the 2010s were the first decade without a bear market, defined as a 20% drop from any peak.

For the record, US equities:

  • experienced six separate 10% corrections over the 2010s (to date!); and
  • In total have returned 249% in the past 10 years, about 1.2 times the historical average.

The US is amid the longest bull market ever (longest period in history without a bear market).

These gains have come when least expected.

 

They also follow a -20% decline over the previous decade (2000 – 2009). Which includes a -52% decline of the Great Recessions (Global Financial Crisis (GFC) – measured over the period October 2007 – February 2009. As at October 2007 the S&P 500 Index had only climbed 11% since the beginning of the decade.

 

How Good has it been?

As Bloomberg note, based on the Sharpe ratio, which tracks the performance of equity markets relative to Government Bonds, adjusted for the volatility of equity markets, the current Sharpe Ratio of the S&P500 is the best among any decade since at least Dwight Eisenhower’s presidency.

The last decade has not been all plain sailing and includes the following market events: May 2010 flash crash, Europe’s sovereign debt crisis in 2011 and ’12, and China’s currency devaluation in 2015.

A previous Post covered these market declines: Equity Market Declines in Perspective

More recently global markets have had to endure an ongoing trade and technology dispute between the US and China.

Central Bank actions, including the lowering of interest rates and quantitative easing (i.e. buying of market securities, mainly fixed income) has helped ease markets anxiety. This is reflected in the decline of market volatility indices, such as the VIX Index.

 

What does the next decade look like?

The sharemarket and economy are linked.

Generally a bear market (i.e. 20% or more fall in value) does not occur without a recession (a recession is often defined as two consecutive quarters of negative economic growth).

Currently there are no excesses within the US economy, that normally precede a recession e.g. elevate inflation, excessive house prices, and high household debt levels.

This would tend to indicate that global equity markets can move higher.

 

Nevertheless, US equity market valuations are high, as are those of global Fixed Income markets.  This environment has resulted in many reporting the death of the traditional Balanced Portfolio (60% listed equities / 40% fixed income).

There are growing expectations that returns over the next decade will be lower than those experienced over the last ten years, as highlight in a previous Post: Low Return Environment Forecasted.

That Post has the following Table, GMO’s expected 7 year returns as at 31 July 2019. They estimated the real returns (returns after 2.2% inflation) for the following asset classes as follows:

Share Markets Annual Real Return Forecasts
US Large Capitalised Shares -3.7%
International Shares 0.6%
Emerging Markets 5.3%
Fixed Income Markets
US Fixed Income -1.7%
International Fixed Income Hedged -3.7%
Emerging Debt 0.7%
US Cash 0.2%

As GMO highlight, these are forward looking based on their reasonable beliefs and they are no guarantee of future performance.   Actual results may differ materially from those anticipated in forward looking statements.

 

It is very rare for decade of strong returns to be followed by a similar like decade.  Only time will tell.

Nevertheless, there is little doubt that a challenging investment environment is likely in the not too distant future. This Post outlines how to prepare and consider investing for such a challenging environment: Investing in a Challenging Investment Environment.

 

Happy investing.

Please read my Disclosure Statement

 

For a historical perspective of previous sharemarket corrections and bear markets please see my previous Post: History of Sharemarket corrections – An Anatomy of equity market corrections

Meanwhile, this Post, Recessions, Inverted Yield Curves and Sharemarket Returns, outlines the inter-play between the economic cycle and sharemarket returns.

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Low Return Environment Forecasted

Many commentators highlight the likelihood of a low return environment over the next 5 -10 years or more.

Even looking through the shorter-term challenges of the current market environment as highlighted in a recent Post, many publicly available forecasts underline the potential for a low return environment over the longer term.

The most often referenced longer-term return forecasts are the GMO 7 Year Asset Class Forecast.

As at 31 July 2019 they estimated the real returns (returns after 2.2% inflation) for the following asset classes as follows:

Share Markets

Annual Real Return Forecasts

US Large Capitalised Shares

-3.7%

International Shares

0.6%

Emerging Markets

5.3%

   
Fixed Income Markets  
US Fixed Income

-1.7%

International Fixed Income Hedged

-3.7%

Emerging Debt

0.7%

US Cash

0.2%

 

As GMO highlight, these are forward looking returns based on their reasonable beliefs and they are no guarantee of future performance.

Actual results may differ materially from those anticipated in forward looking statements.

 

The variation in sequence of returns is an additional consideration e.g. global sharemarkets could continue to move higher and then fall sharply to generate a 0.6% annual return over the next seven years. Or they could do the reverse, fall sharply within the next year and then float higher over the next 6 years to generate the 0.6% return.

 

The sequencing of returns is important for those in the retirement death zone, see my previous Post on the riskiest time of saving for and being in retirement.

 

Looking at the return forecasts the following observations can be made:

  • Within equity markets Emerging Markets are offering more value and US equities the least; and
  • The return expectations for Fixed Income are very dire, particularly for those developed markets outside of the US.

 

For comparison purposes, the long-term return of US equities is 6.5%.

 

The Fixed Income returns reflect that more than $US15 trillion of fixed income securities across Europe and Japan are trading on a negative yield.

Based on some measures, interest rates are at their lowest level in 5,000 years!

 

GMO is not alone with such longer-term market forecasts, those from Research Affiliates and State Street are provided below. They all have different methodologies and approaches to calculating their forecasts. Notably, they are all pointed in a similar direction.

 

This analysis highlights that outstanding returns have been delivered over the last 10 years, particularly if you are invested in the US and New Zealand sharemarkets and have had longer dated interest rate exposures.

The Balance Portfolio (60% Equities and 40%) has benefited from this environment.

The last 10 years have been amongst the best for a New Zealand investor invested in a Balanced Portfolio, if they had managed to stay fully invested during that time.

The New Zealand sharemarket has returned 13.3% over the last 10 years and New Zealand Government Bonds 5.9%. Therefore, a Balanced Fund has returned 10.3% over the last decade!

Global Equites have returned 10.0%, led higher by the US sharemarket, and Global Bonds 4.3% over the last 10 years. Globally, the Balanced Portfolio has benefited from the 35 year long decline in interest rates.

 

Therefore, the forecast returns are pretty frightening from a Balanced Fund perspective. Certainly, returns are not likely to be as strong over the next ten years as they have been over the last decade.

This calls into question the level diversification of a Balanced Fund of only equities and fixed income.

This issue can be considered from two angles, the need to increase the level of diversification within a Balanced Portfolio and the effectiveness of fixed income in providing diversification benefits to a Balanced Portfolio given historically low interest rates.

On the first issue, although a lack of true portfolio diversification has not disadvantaged investors greatly over the last 5-10 years, the potential to earn other sources of returns from true portfolio diversification may be of more value over the next 10 years. It is certainly a risk that should be considered and managed.

With regards the effectiveness of fixed income in diversify sharemarket risk in the future, this dynamic is best captured by the following insightful observation by Louis Grave: investors are hedging overvalued growth stocks with overvalued bonds.

What he is saying, is that given current valuations in the US of both the sharemarket and fixed income a Balanced Portfolio no longer has the degree of diversification it once had.

Of course, interest rates could fall further, and provide some offset from a falling sharemarket, as they have historically. Nevertheless, the effectiveness and extent of this offset is limited given historically low interest rates.

Most importantly, given current valuations, there is the scenario where both fixed income and sharemarkets underperform at the same time. This would be like the stagflation environment of 1970, where inflation is rising, and economic growth is muted.  This is a scenario worth considering.

In my mind the biggest risks to portfolios are in longer term fixed income securities or “bond proxies”, such as slow-growth and dividend-oriented investments.  Listed Property and infrastructure securities would fall into this definition.

It is quite likely that those looking for diversification benefits from listed property, global and domestic, and listed infrastructure, are likely to be disappointed. As they would had been during the Global Financial Crisis. They only provide limited portfolio diversification benefits, not true portfolio diversification.

 

The expected low returns environment throws up a lot of issues to consider:

  • True Portfolio diversification. Institutional investors accept that portfolio diversification does not come from investing in more and more asset classes. This has diminishing diversification benefits e.g. adding global listed property or infrastructure to a multi-asset portfolio that includes global equities.   True portfolio diversification is achieved by investing in different risk factors that drive the asset classes e.g. duration, economic growth, low volatility, value, and growth. Investors are compensated for being exposed to a range of different risks.

 

  • Consistent with the above, there is a growing evolution within the Wealth Management Industry, a paradigm shift which is resulting in the death of the Policy Portfolio (i.e. Balanced Portfolio).

 

  • The growing risks with traditional market indices and index funds, as highlighted by the low return forecasts.

 

  • Increased innovation within Exchange Traded Funds as investors seek to diversify their traditional market exposures.

 

I plan to write more on the last two points in future Posts.

 

Happy investing.

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand.  Building more Robust Investment Portfolios

 

 

Research Affiliates – 10 Year Forecast Real (After Inflation)

Share Markets

Real Return Forecasts

US Large Capitalised Shares

0.7%

International Shares

3.2%

Emerging Markets

7.7%

   
Fixed Income Markets  
US Fixed Income

-0.8%

International Fixed Income Hedged

-0.5%

Emerging Debt

4.2%

US Cash

-0.3%

 

State Street also provides:

  • They are more optimistic in relation to developed market sharemarket, with Emerging Markets outperforming developed markets, Global Listed Property underperforms both developed and emerging market equities
  • They see very low returns from Global Fixed Income.

Investing in a Challenging Investment Environment

The Global financial backdrop can be summarised as:

  1. Late Cycle
    • The US economy is into its longest period of uninterrupted growth, it has been over ten years since the Global Financial Crisis (GFC) and the US experiencing a recession.
    • Likewise, the US sharemarket is into it longest period without incurring a 20% or more fall (which would be a bear market).
  2. Exceptionally low interest rates. As you will be aware over $14 trillion of European and Japanese fixed income securities are trading on negative interest rates.
  3. Central Banks around the world are reducing short-term interest. By way of example, the US Federal Reserve has undertaken a mid-cycle adjustment, with more to come, the European Central Bank recently cut interest rates, as has China’s Central Bank. The Reserve Bank of Australia and the Reserve Bank of New Zealand have reduced cash rates very aggressively in recent months. It appears that interest rates will remain lower for longer.
  4. Rising geo-political risk, namely an ongoing and escalating trade dispute between the US and China, while Brexit has a cameo role on the global stage, and there are rising tensions in the middle-east.
  5. Global growth has slowed. The pace of economic activity has slowed around the world, this is most noticeable in Europe, Japan, and China, and is concentrated within the manufacturing sector. The service sectors have largely been unaffected.

 

Against this backdrop the US sharemarket has outperformed, continually reaching all-time highs, likewise for the New Zealand sharemarket.

Value stocks have underperformed high growth momentum stocks. The performance differential between value and growth is at historical extremes.

Lastly emerging Markets have underperformed the developed world.

 

A good assessment of the current environment is provided in this article by Byron Wien. It is a must read, Plenty to worry about but not much to do.

 

It is not all gloom and doom

The US consumer is in very good shape, reflecting record low unemployment, rising wages, and a sound property market. The US consumer is as bigger share of the global economy as is China. Although it is not growing as fast as China, a solid pace of growth is being recorded.

Overall, economic data in the US has beaten expectations over recent weeks (e.g. retail sales).

Globally the manufacturing sectors are expected to recover over the second half of this year, leading to a rebound in global growth. Low interest rates will also help global growth.  Nevertheless, growth will remain modest and inflation absent.

Globally, in most countries, Sharemarket’s dividend yields are higher than interest rates. This means that sharemarkets can fall in value over the next 5-10 years and still outperform fixed income.

 

How to invest in current environment

Recently there has been #TINA movement: There Is No Alternative to Equities.

Certainly equities have performed strongly on a year to date basis, so have fixed income securities (their value increases as interest rates fall).

The traditional 60/40 portfolio, 60% Equities and 40% Fixed Income, has performed very strongly over the last 6-9 months, this comes after a difficult 2018.

#TINA and the longer term performance of the 60/40 portfolio is covered in this AllAboutAlpha Article, which is well worth reading.

The 60/40 portfolio has performed well over the last 10 years, and has been a strong performer over the longer term.

This performance needs to be put into the context that interest rates have been falling for the last 35 years, this has boosted the returns from the Fixed Income component of the portfolio.  Needless to say, this tail wind may not be so strong in the next 35 years.

This indicates that future returns from a 60/40 portfolio will be lower than those experienced in more recent history.

There are lots of suggestions as to what one should do in the current market environment.  This article on Livewire Markets provides some flavour.

No doubt, you will discuss any concerns you have with your Trusted Advisor.

 

At a time like this, reflect on the tried and true:

Seek “True” portfolio Diversification

The AllAboutAlpha article references a Presentation by Deutsche Bank that makes “a very compelling case for building a more diversified portfolio across uncorrelated risk premia rather than asset class silos”.

The Presentation emphasises “The only insurance against regime shifts, black swans, the peso problem and drawdowns is to seek out multiple sources of risk premia across a host of asset classes and geographies, designed to harvest different features (value, momentum, illiquidity etc.) of the return generating process, via a large number of small, uncorrelated exposures

The above comments are technical in nature and I will explain below. Albeit, the Presentation is well worth reading: Rethinking Portfolio Construction and Risk Management.

 

In a nutshell, the above comments are about seeking “true” portfolio diversification.

Portfolio diversification does not come from investing in more and more asset classes i.e. asset class silos. This has diminishing diversification benefits over the longer term and particularly at the time of market crisis e.g. adding global listed property or infrastructure to a multi-asset portfolio that already includes global equities.

True portfolio diversification is achieved by investing in different risk factors (i.e. premia) that drive the asset classes e.g. duration, economic growth, low volatility, value, and growth by way of example.

Investors are compensated for being exposed to a range of different risks. For example, those risks may include market beta (e.g. equities and fixed income), smart beta (e.g. value and momentum factors), alternative and hedge fund risk premia, illiquidity e.g. Private Equity, Direct Property, and unlisted infrastructure. And of course, true alpha from active management, returns that cannot be explained by the risk exposures just outlined. There has been a disaggregation of returns.

US Endowment Funds and Sovereign Wealth Funds have led the charge on true portfolio diversification, along with the heavy investment into alternative investments and factor exposures. They are a model of world best investment management practice.

Therefore, seek true portfolio diversification, this is best way to protect portfolio outcomes and reduce the reliance on sharemarkets and interest rates driving portfolio outcomes.

As the Presentation says, a truly diversified portfolio provides better protection against large market falls and unexpected events i.e. Black Swans.

True diversification leads to a more robust portfolio.

(I have written a number of Post on Alternatives and the expected growth in institutions investing in alternatives globally.)

 

Customised investment solution

Often the next bit advice is to make sure your investments are consistent with your risk preference.

Although this is important, it is also fundamentally important that the investment portfolio is customised to your investment objectives and takes into consideration a wider range of issues than risk preference and expected returns and volatility from capital markets.

For example, income earned up to and after retirement, assets outside super, legacies, desired standard of living in retirement, and Sequencing Risk (the period of most vulnerability is either side of the retirement age e.g. 65 here in New Zealand).

 

Think long-term

I think this is a given, and it needs to be balanced with your customised investment objectives as outlined above. Try to see through market noise, don’t over trade and don’t take on more risk to chase returns.

It is all right to do nothing, don’t be compelled to trade, a less traded portfolio is likely more representative of someone taking a longer term view.

Also look to financial planning options to see through difficult market conditions.

 

There are a lot of Investment Behavioural issues to consider, the idea of the Regret Portfolio approach may resonate, and the Behavioural Tool Kit could be of interest.

 

AllAboutAlpha has a great tagline: “Seek diversification, education, and know your risk tolerance. Investing is for the long term.”

Kiwiinvestorblog is all about education, it does not provide investment advice nor promote any investment and receives no payments. Please follow the links provided for a greater appreciation of the topic in discussion.

 

And, please, build robust investment portfolios. As Warren Buffet has said: “Predicting rain doesn’t count. Building arks does.” ………………….. Is your portfolio an all weather portfolio?

 

Happy investing.

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Could Buffett be wrong?

As has been widely reported Warren Buffett frequently comments on the benefits of investing in low-cost index funds.

He’s reportedly instructed the trustee of his estate to invest in index funds. “My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund,” he noted in the Berkshire Hathaway’s 2013 annual letter to shareholders.

 

Not that I want to disagree with Buffett, I have enormous respect for him, incorporate many of his investment insights and philosophies into my own investment approaches. Albeit, I think he might be wrong on this account.

And this is not to say Index Funds do not have a part to play in a portfolio, nor that investment fees are not important. They are. I do think more portfolios should be invested along the lines of Endowments. Broad diversification is the key.

 

Following Buffett could be the right advice for a young person starting out with many years until retirement.  Such an investor would need to weather the volatility of being largely invested in equities, which is no mean achievement when equity markets can suffer falls of over 40%. A high equity strategy can become horribly undone.

Nevertheless, as one gets closer to retirement and is in retirement Buffett’s strategy is unsuitable.

Similarly Buffett’s strategy is not appropriate for a Pension Fund or Endowment. These Funds are in a similar position to those in retirement. Meanwhile, the equity allocation should be reduced as one gets closer to retirement.

The short comings of a higher equity allocation was highlighted in a recent article  by Charles E.F. Millard, who is a consultant to AQR Capital Management, LLC.

 

Once an investor needs to take capital or income from a portfolio volatility of the equity markets can wreak havoc on a Portfolio’s value, and ultimately the ability of a portfolio to meet its investment objectives.

The key point that Millard makes is that Pension Funds and Endowments are required to make periodic payment obligations. So do those in retirement, they either draw capital or income from the portfolio to sustain a desired standard of living.

 

Ultimately, it the drawing of an income or the payments by Endowments that consume most of the investment returns. “This is why assets don’t just mushroom over time.”

As Millard explains, “each year endowments usually pay out at least 5% of their holdings, and the institutions they support tend to count on those funds. That changes the situation an awful lot.”

Let’s look at the math. Millard explains”

and assume that each year the endowment pays out 5% of its assets. In that case, starting at $1 million, the endowment would not have the $5.3 billion Buffett imagines. Rather, after having paid out almost $145 million along the way, the endowment would have less than $150 million remaining”

Still a great result, but far from the billions assumed by Buffett.

It is also worth noting that a Pension’s obligation (liability) can continue to grow as employees retire and live longer. The Pension Fund has no ability to reduce its payouts and must manage this risk.

 

This is where market volatility comes into play, particularly drawdowns – a large fall in the value of the market.

“In a prolonged stock market drawdown, those growing benefit payments will consume a larger share of the shrunken plan assets.  So, they can’t take too much solace in long-run optimism when in the intermediate run they’re already paying out much of their capital.”

 

This is a key point. You can’t take comfort in the long-term returns from equities when you are running out of money!

Equity markets do fall in value and this is why institutions with meaningful annual pay-out obligations are not invested only in equities.

 

No argument that equities will not outperform over the longer term, this is highly likely. Yet this observation fails to recognise the volatility inherent in equities.

Millard:

“Over Buffett’s 77 years investing, the endowment CIO would see fund assets decline in 23 out of 77 years (when equity returns didn’t cover the 5% distribution), and in the average bad year, the fund would shrink by -12%. But at least an endowment may be able to reduce its spending; a pension fund can’t, so in a bad year, the fraction of pension assets that must be paid out increases substantially. This is why most institutional investors subscribe to a concept that Buffett seems to hate – diversification. He’s said it’s “a protection against ignorance.” We think it is more a protection against hubris.”

Diversification is key.

“It is worth noting that Institutions do not seek to maximize potential long-term returns, without regard to risks. They often seek to maximize the likelihood that they can meet their payout obligations. They seek to be reliable payers of those obligations. And in the case of pensions, they also seek to make it possible for the employer to have somewhat predictable and affordable contribution obligations. A portfolio of stocks alone doesn’t do that. That’s why asset class diversification is a bedrock principle of modern investing.

 

In short, institutional investors have different goals and obligations to Buffett.

For those in retirement, their goals and obligations are more closely aligned with the Pension Fund and Endowment, than Buffett and Berkshire Hathaway. Those closer to retirement need to make sure that market volatility does not impact them and their ability to sustain the standard of level they wish to maintain in retirement.

 

Happy investing.

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

The balancing act of the least liked investment activity

A recent Research Affiliates article on rebalancing noted: “Regularly rebalancing a portfolio to its target asset mix is necessary to maintain desired risk exposure over the portfolio’s lifetime. But getting investors to do it is another matter entirely—many would rather sit in rush-hour traffic! “

“A systematic rebalancing approach can be effective in keeping investors on the road of timely rebalancing, headed toward their destination of achieving their financial goals and improving long-term risk-adjusted returns.”

Research Affiliates are referencing a Wells Fargo/ Gallup Survey, based on this survey “31% of investors would opt to spend an hour stuck in traffic rather than spend that time rebalancing their portfolios. Why would we subject ourselves to gridlock instead of performing a simple task such as rebalancing a portfolio?

 

I can’t understand why rebalancing of an investment portfolio is one of least liked investment activity, it adds value to a portfolio overtime, is a simple risk management exercise, and is easy to implement.

It is important to regularly rebalance a Portfolio so that it continues to be invested as intended to be.

 

A recent article in Plansponsor highlighted the importance of rebalancing. This article also noted the reluctance of investors to rebalance their portfolio.

As the article noted, once an appropriate asset allocation (investment strategy) has been determined, based on achieving certain investment goals, the portfolio needs to be regularly rebalanced to remain aligned with these goals.

By not rebalancing, risks within the Portfolio will develop that may not be consistent with achieving desired investment goals. As expressed in the article “Participants need to make sure the risk they want to take is actually the risk they are taking,” …………..“Certain asset classes can become over- or under-weight over time.”

Based on research undertaken by BCA Research and presented in the article “Rebalancing is definitely recommended for all investors, perhaps more so for retirement plan participants than others, as they are more likely to be concerned with capital preservation than capital appreciation.”

The following observation is also made “While a portfolio that is not rebalanced will have a greater allocation to equities during a bull market and, therefore, outperform a rebalanced portfolio, all rebalanced portfolios outperformed an unbalanced portfolio during periods leading up to market corrections and recessions,” Hanafy says, citing a BCA Research study which looked at three main rebalancing scenarios of a simple 60/40 portfolio since 1973.

The potential risks outlined above is very relevant for New Zealand and USA investors currently given the great run in the respective sharemarkets over the last 10 years.

When was last time your investment fiduciary rebalanced your investment portfolio?

 

Rebalancing becomes more important as you get closer to retirement and once in retirement:

“There are two main components to retirement plans: returns and the risk you take,” …… “When you do not rebalance your portfolio, a participant could inadvertently take on too much risk, which would expose them to a market correction. This is important because, statistically, as participants reach age 40 to 45, how much risk they take on is far more important than how much they save. When you are young, the most important thing is how much you save.”

Rebalancing Policy

As the article notes, you can systematically set up a Portfolio rebalancing approach based on time e.g. rebalance the portfolio every Quarter, six-months or yearly intervals.

It is not difficult!

Alternatively, investment ranges could be set up which trigger a rebalancing of the portfolio e.g. +/- 3% of a target portfolio allocation.

Higher level issues to consider when developing a rebalancing policy include:

  • Cost, the more regularly the portfolio is rebalanced the higher the cost on the portfolio and the drag on performance. This especially needs to be considered where less liquid markets are involved;
  • Tax may also be a consideration;
  • The volatility of the asset involved;
  • Rebalancing Policy allows for market momentum. This is about letting the winners run and not buying into falling markets too soon. To be clear this is not about market timing. For example, it could include a mechanism such as not rebalancing all the way back to target when trimming market exposures.

 

My preference is to use rebalancing ranges and develop an approach that takes into consideration the above higher level issues. As with many activities in investing, trade-offs will need to be made, this requires judgement.

 

As noted above, it appears that rebalancing is an un-liked investment activity, if not an over looked and underappreciated investment activity. This seems crazy to me as there is plenty of evidence that a rebalancing policy can add value to a naïve monitoring and “wait and see” approach.

I think the key point is to have a documented Rebalancing Policy and be disciplined in implementing the Policy.

 

This also means that those implementing the Rebalancing Policy have the correct systems in place to efficiently carry out the Portfolio rebalancing so as to minimise transaction costs involved.

Be sure, that those responsible for your investment portfolio can efficiently and easily rebalance your portfolio. Importantly, make sure the rebalancing process is not a big expense on your portfolio e.g. trading commissions and the crossing of market spreads (e.g. difference between buy and sell price), and how close to the “market price” are the trades being undertaken?

These are all hidden costs to the unsuspecting.

 

A couple of last points:

  • It was noted in the recent Kiwi Investor Blog on Behaviour Finance that rebalancing of the portfolio was an import tool in the kit in helping to reduce the negative impact on our decision making from behavioural bias. It is difficult to implement a rebalancing policy when markets are behaving badly, discipline is required.
  • The automatic rebalancing nature of Target Date Funds is an attractive feature of these investment solutions.

 

To conclude, as Research Affiliates sums up:

  1. Systemic rebalancing raises the likelihood of improving longer-term risk-adjusted investment returns
  2. The benefits of rebalancing result from opportunistically capitalising on human behavioural tendencies and long-horizon mean reversion in asset class prices.
  3. Investors who “institutionalise contrarian investment behaviour” by relying on a systematic rebalancing approach increase their odds of reaping the rewards of rebalancing.

 

It is not hard to do.

 

Happy investing.

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Recessions, inverted yield curves, and Sharemarket returns

Fears of economic recession, particularly in the US, peaked over the final three months of 2018.

Nevertheless, talk of economic recession has now faded into the background after the US Federal Reserve hit the pause button to further interest rate increases in January of 2019. The Fed is not expected to raise interest rates again in 2019.

This is not to say that a recession will not occur, it will at some stage, just as night follows day. The economic/business cycle has not been conquered.

Nevertheless, the timing of the next recession is unknown. Take Australia for example, their last recession was over 28 years ago. New Zealand is over 9 years since their last recession.

With regards to the US, in July of this year the US economy will enter its longest period in history without incurring a recession. Their economy remains on a sound footing: interest rates remain low, the US consumer is confident, businesses are investing, the Government is increasing spending, and forward looking indicators of economic activity remain positive. Lastly, housing activity is likely to pick up over the second half of 2019.

 

What is a Recession?

A recession is defined as at least two consecutive quarters of declining economic growth. The US National Bureau of Economic Research (NBER) defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real gross domestic product (GDP), real income, employment, industrial production and wholesale-retail sales.”

 

A recent article by the Capital Group: Preparing for the next recession: 9 things you need to know provides a good overview of the ins-and-outs of economic recession.

 

The good news, as Capital highlight, recessions generally aren’t very long.

Capital undertook analysis of 10 US economic cycles since 1950. This analysis showed that recessions have lasted between eight and 18 months, with the average spanning about 11 months. Unfortunately New Zealand’s history is a little more chequered than the US.

Investors with a long-term investment horizon, should expect to experience a number recession over their investment horizon and therefore look through the full economic cycle. Fortunately, for most of us, we spend more time in economic expansion than in recession.

Capital note, “over the last 65 years, the U.S. has been in an official recession less than 15% of all months.”

The following graph highlights the average length, total growth, and returns from the average stock market return over the average recession and economic expansion.

Notably, “equity returns can even be positive over the full length of a contraction, since some of the strongest stock rallies have occurred during the late stages of a recession.”

The human cost of economic recession is provided in the form of jobs lost and this should not be forgotten.

 

Economic cycles Capital.jpg

 

From a sharemarket perspective, a bear market, defined as a 20% or more fall in value, usually overlaps with recessions.

Share markets tend to lead the economic cycle, given they are forward looking. Sharemarkets on average peak six months prior to the onset of a recession. They continue to fall during the early stages of a recession.

The recovery in sharemarkets often takes hold while the economy is still in recession (economic growth is still contracting).

The initial bounce in sharemarkets is often a period of strong performance and occurs before there is any hard evidence of a pickup in economic activity.

The following graph presents the above sequencing and overlapping nature of sharemarket returns and recessions.

Sharemarket returns and recession cycles.png

 

Having said all that, stock markets are not good predictors of economic recession i.e. a sharp fall in global sharemarket does not mean there will be an onset of global economic recession.

This is captured by the well know quote from Paul Samuelson: “The stock market has predicted nine of the last five recessions.”

 

Sharemarket Returns and Inverted Yield Curves

There has been a lot of discussion over the last twelve months about the implications of an inverted US yield curve. (An inverted yield curve is when longer-term interest rates (e.g. 10 years) are lower than shorter-term interest rates (e.g. 2 years or 3 months). A normal yield curve is when longer-term-interest rates are higher than shorter-term-interest rates.

Parts of the US yield curve are currently inverted, and this inversion has increased over recent days.

The significance of this is that prior to the last 7 US recessions the yield curve has inverted prior each time. An inverted yield curve has by and large been a good predictor of recession.

Nevertheless, not every time the yield curve inverts does a recession follow and on average the inversion of the yield curve occurs 12 months prior to a recession.

 

The following analysis undertaken by Wellington Management looks at the performance of the US sharemarket in relation to yield curves inversions.

The period of analysis is from the 1950s at which time the US Federal Reserve gained full, independent control over interest rates from the US Treasury. As Wellington note, “it was after this transition that the yield curve became an effective tool for gauging the impact of monetary policy on the economy and the prospect of a recession.”

Wellington present the following analysis and the Table below:

  • “As shown in the third column (of Table below), the S&P 500 peaked ahead of a yield-curve inversion only twice (1959 and 1973).
  • “The median time between inversion and peak equity returns was 17 months, and in several cases the market peaked almost two years or more after inversion.”
  • “Aggregate equity returns post-inversion have been partly dependent on the length of time between the initial inversion and the start of the recession.”
  • “Since returns tend to be negative right around the time a recession begins, the instances in which there was a shorter period between the initial inversion and the start of the recession were more likely to have a negative return.”

 

Just like there is a period of time between economic recession and an inverted yield curve, the sharemarket often peaks after the yield curves inverts.

Sharemarket returns and inverted yield curves.png

 

Back to the Capital article, for it also runs through a number of other recession related questions.

Of interest are:

What economic indicators can warn of a recession?

  • Capital outline some generally reliable signals worth watching closely, such as an inverted yield curve, corporate profits, unemployment, and leading economic indices.
  • Importantly it is appropriate to look at and consider several different economic indicators.

 

What Causes Recessions?

  • There are many reasons for a recession, chief amongst them are rising interest rates, particularly by Central Banks such as the US Federal Reserve and Reserve Bank of New Zealand, imbalances within an economy e.g. excess housing prices, high debt levels
  • Every economic cycle is unique, but anything that impacts on corporate profits or consumer spending, such as rising unemployment, are factors to consider.

 

Just remember is it notoriously difficult to predict economic recession and they are normally the result of a number of factors that have a cascading effect leading to an economic downturn.

 

The following Kiwi Investor Blog Posts maybe of interest to those wanting a better understanding of inverted yield curves, leading economic indicators, and historical performance of equity market corrections.

Recession predictability of inverted yield curves and other economic indicators to considered:

 

Analysis of Sharemarket corrections and market declines

 

Lastly the Capital article provides some suggestions as to how to position your portfolio for a recession. I think it is exceedingly difficult to finesse a portfolio in the expectations of a recession.

From my perspective, the following is most critical:

  • Maintain a long-term perspective;
  • Implement a balanced and broadly diversified portfolio. Portfolio diversification does not come from investing in more and more asset classes. This has diminishing diversification benefits. True portfolio diversification is achieved by investing in different risk factors that drive the asset classes e.g. duration (movements in interest rate), economic growth, low volatility, value, and growth. Investors are compensated for being exposed to a range of different risks;
  • Know you risk tolerance: what level of volatility in capital are you prepared to handle without changing your mind;
  • Understand your risk capacity: the amount of risk you need to take in order to reach your financial goals;
  • Implement a goals-based investment approach, where success is measured on how you are tracking relative to your investment goals, rather than market index performances; and
  • Always maintain a high quality portfolio, with plenty of liquidity, and limit the level of turnover across the portfolio e.g. amount of trading (buying and selling)

 

A good advisor should be able to help you with the above and see you through bouts of sharemarket volatility, including a recession environment.

 

Happy investing.

 

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

cropped-title-picture-enhanced.jpg

Pioneering work on yield-curve inversions and risk of economic recession

There is no doubt that global economic growth has slowed over the last six months. The Reserve Bank of New Zealand (RBNZ) highlighted rising global economic risks in its recent Policy statement. The RBNZ noted that economic growth has slowed in our major trading partners of Australia, China, and Europe.

Economic growth has also slowed in the US. Although US financial conditions have eased in recent months, they did tightened over the course of 2018.

The risk of a US recession has risen in recent months. Albeit calls of a US recession have been around for some time.

A recent article by Gary Shilling in Think Advisor captures the type of the analysis undertaken on the US economy over the last 18 months.

Leading economic indicators for the US have weakened. Nevertheless, they are not consistent with forecasting a looming recession, except perhaps one, an inverted yield curve which is discussed below.

Overall the US economy is in good health, with record low unemployment, growing incomes, high saving rates, strong household balance sheets, business investment is set to increase, as is Government spending.

 

As Shilling notes in his article, the US economy could go several ways e.g. economic growth rebounds over 2019, the US experiences a period of prolonged moderate economic growth without a recession, or the US experiences a classic economic cycle and tips into a recession at a later date due to the US Federal Reserve raising interest rates.

By Shilling’s count, there have been 12 occasions since World War 2 that the Fed raising interest rates has resulted in a recession. Presently, this would appear some time away  given the Fed has indicated it is unlikely to undertake further interest rate increases in 2019.

The later scenario is most consistent with the consensus view – it is a little early to call a US recession, yet the risks of a recession within the next 2-3 years are growing. For the time being the US continues to expand and will enter its longest period of economic expansion in modern history in July 2019. Recession will eventually be triggered by the Fed increasing interest rates resulting in a more “garden variety” recession.

 

And this leads to a key point in Shilling’s article, the word recession invokes images of a Global Financial Crisis (GFC) type outcome – not surprising given this was our last experience.

His expectations are that the next US recession will not be as severe as the GFC.

He has a similar view with respect to the next US “Bear” market (i.e. fall in value of greater than 20%).

I’ll leave it to him to explain:

“Recession” conjures up specters of 2007-2009, the most severe business downturn since the 1930s in which the S&P 500 Index plunged 57 percent from its peak to its trough. The Fed raised its target rate from 1 percent in June 2004 to 5.25 percent in June 2006, but the main event was the financial crisis spawned by the collapse in the vastly-inflated subprime mortgage market.

 Similarly, the central bank increased its policy rate from 4.75 percent in June 1999 to 6.5 percent in May 2000.  Still, the mild 2001 recession that followed was principally driven by the collapse in the late 1990s dot-com bubble that pushed the tech-laden Nasdaq Composite Index down by a whopping 78 percent.

The 1973-1975 recession, the second deepest since the 1930s, resulted from the collapse in the early 1970s inflation hedge buying of excess inventories. That deflated the S&P 500 by 48.2 percent. The federal funds rate hike from 9 percent in February 1974 to 13 percent in July of that year was a minor contributor.

The remaining eight post-World War II recessions were not the result of major financial or economic excesses, but just the normal late economic cycle business and investor overconfidence. The average drop in the S&P 500 was 21.2 percent.

 

In short, history shows that US sharemarkets drop by about 21% when the economy falls into recession, remembering the S&P 500 fell almost 20% during the last three months of 2018.

 

Inverted Yield Curve

As you will know, the slower economic growth has resulted in several Central Banks, with the RBNZ the latest, to turn more cautious on the outlook for economic growth and inflation. This list includes the US Federal Reserve, European Central Bank, and Reserve Bank of Australia.

This sudden change in direction of interest rate policy (Monetary Policy) has witnessed a flattening of yield curves (when longer-dated interest rates are at similar level to shorter-term interest rates).

In the US, the yield curve has become inverted, where longer-term interest rates are lower than shorter-term interest rates.

The inversion has primarily been due to the significant reduction in longer-term interest rates rather than the increase in shorter-term interest rates (inversions normally occur when short term interest rates are increased rapidly by Central Banks).

The significance of this is that prior to the last 7 US recessions the yield curve has inverted each time.

Nevertheless, not every time the yield curve inverts does a recession follow and on average the inversion of the yield curve occurs 12 months prior to a recession.

 

As you can imagine a lot has been written in recent weeks on the implications of a negative yield curve, I would like to highlight the following three articles, which pretty much sums up the current debate:

  1. A very recent interview with the person who undertook in 1986 the pioneering work on yield-curve inversions and their foreshadowing of economic downturns (RA-Conversations)
  2. Mohamed A. El Erain’s article of “Beware of Misreading Inverting Yield Curve “
  3. BCA LinkedIn Post, Yield Curve Inversions and S&P 500 Peaks, don’t get bogged down in the noise.

 

It would appear, that when it comes to the current inversion of the US yield curve, we have “Nothing to fear but fear itself” (Franklin D. Roosevelt). This is certainly the view of Mohamed A. El Erain.

 

I have blogged previously on the history of inverted yield curves and their predictive ability. Similar there is also a previous post on the anatomy of equity Bear markets.

 

Happy investing.

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Please see my Disclosure Statement

The Regret Proof Portfolio

Based on analysis involving the input of Daniel Kahneman, Nobel Memorial Prize-winning behavioural economist, a “regret-proof” investment solution would involve having two portfolios: a risky portfolio and a safer portfolio.

Insurance companies regularly implement a two-portfolio approach as part of their Liability Driven Investment (LDI) program: a liability matching portfolio and a return seeking portfolio.

It is also consistent with a Goal Based Investing approach for an individual: Goal-hedging portfolio and a performance seeking portfolio. #EDHEC

Although there is much more to it than outlined by the article below, I find it interesting the solution of two portfolios came from the angle of behavioural economics.

I also think it is an interesting concept given recent market volatility, but also for the longer-term.

 

Background Discussion

Kahneman, discussed the idea of a “regret-proof policy” at a recent Morningstar Investment Conference in Chicago.

“The idea that we had was to develop what we called a ‘regret-proof policy,’” Kahneman explained. “Even when things go badly, they are not going to rush to change their mind or change and to start over,”.

According to Kahneman, the optimal allocation for someone that is prone to regret and the optimal allocation for somebody that is not prone to regret are “really not the same.”

In developing a “regret-proof policy” or “regret minimization” Portfolio allows advisors to bring up “things that people may not be thinking of, including the possibility of regret, including the possibility of them wanting to change their mind, which is a bad idea generally.”

 

In developing a regret proof portfolio, they asked people to imagine various scenarios, generally bad scenarios, and asked at what point do you want to bail out or change your mind.

Kahneman, noted that most people — even the very wealthy people — are extremely loss averse.

“There is a limit to how much money they’re willing to put at risk,” Kahneman said. “You ask, ‘How much fortune are you willing to lose?’ Quite frequently you get something on the order of 10%.”

 

Investment Solution

The investment solution is for people to “have two portfolios — one is the risky portfolio and one is a much safer portfolio,” Kahneman explained. The two portfolios are managed separately, and people get results on each of the portfolios separately.

“That was a way that we thought we could help people be comfortable with the amount of risk that they are taking,” he said.

In effect this places a barrier between the money that the client wants to protect and the money the client is willing to take risk on.

Kahneman added that one of the portfolios will always be doing better than market — either the safer one or the risky one.

“[That] gives some people sense of accomplishment there,” he said. “But mainly it’s this idea of using risk to the level you’re comfortable. That turns out to not be a lot, even for very wealthy people.”

 

I would note a few important points:

  1. The allocation between the safe and return seeking portfolio should not be determined by risk profile and age alone. By way of example, the allocation should be based primarily on investment goals and the client’s other assets/source of income.
  2. The allocation over time between the two portfolios should not be changed based on a naïve glide path.
  3. There is an ability to tactically allocate between the two portfolios. This should be done to take advantage of market conditions and within a framework of increasing the probability of meeting a Client’s investment objectives / goals.
  4. The “safer portfolio” should look more like an annuity. This means it should be invested along the lines that it will likely meet an individual’s cashflow / income replacement objectives in retirement e.g. a portfolio of cash is not a safe portfolio in the context of delivering sufficient replacement income in retirement.

 

Robust investment solutions, particularly those designed as retirement solutions need to display Flexicurity.   They need to provide security in generating sufficient replacement income in retirement and yet offer flexibility in meeting other investment objectives e.g. bequests.  They also need to be cost effective.

The concepts and approaches outlined above need to be considered and implemented in any modern-day investment solution that assists clients in achieving their investment goals.

Such consideration will assist in reducing the risk of clients adjusting their investment strategies at inappropriate times because of regret and the increased fear that comes with market volatility.

Being more goal focussed, rather than return focused, will help in getting investors through the ups and downs of market cycles. A two-portfolio investment approach may well assist in this regard as well.

 

Happy investing.

 

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

2018 was a shocking Year

Well its official, 2018 was a shocking year in which to make money. Not for some time, 1972, has so many asset classes failed to deliver 5% or more in value.

In terms of absolute loses, e.g. Global Financial Crisis (GFC 2007/08), investors have incurred far worst returns than 2018, nevertheless, as far as breadth of asset classes failing to deliver upside returns, 2018 is historical.

 

Here is a run through the numbers:

International Equities were down around 7.4% in local currency terms in 2018:

  • The US was one of the “better” performing markets, yet despite reaching historical highs in January and then again in September, had its worst year since the GFC, December was is its worst December return outcome since the 1930s.
  • The US market entered 2018 on a record run, experiencing it longest period in history without incurring a 5% or more fall in value.  This was abruptly ended in February.
  • During the year the US market reached its longest period in history without incurring a Bear market, defined as a fall in value of more than 20%. Albeit, it has come very close to ending this record in recent months.
  • Elsewhere, many global equity markets are down over 20% from their 2018 peaks and almost all are down over 10%.
  • Markets across Europe and Japan fell by over 12% – 14% in 2018
  • The US outperformed the rest of the world given its better economic performance.
  • The New Zealand sharemarket outperformed, up 4.9%!

Commodities, as measured by the Bloomberg Index, fell over 2018. Oil had its first negative year since 2015, falling 20% in November from 4 year highs reached in October. Even Gold fell in value.

Hedge Fund indices delivered negative returns.

Global credit indices also delivered negative returns, as did High Yield

Emerging Market equities where negative, underperforming developed markets.

Global listed Property and Infrastructure indices also returned negative returns.

Fixed Interest was more mixed, Global Market Indices returned around 1.7%:

  • US fixed interest delivered negative returns for the year, as did US Inflation Protected fixed interest securities. US Longer-term securities underperformed shorter-term securities.
  • NZ fixed interest managed around +4.7% for the year.

The US dollar was stronger over 2018, this provided some relief for those investing outside of their home currency and maintained a low level of currency hedging.

The above analysis does not include the unlisted asset classes such as Private Equity, Unlisted Infrastructure, and Direct Property investments.

 

Two last points:

  • Balance Bear, under normal circumstances, fixed interest, particularly longer-term securities, would perform strongly when equity markets deliver such negative returns as experienced in 2018. This certainly occurred over the last quarter of 2018 when concerns over the outlook for global economic growth became a key driver of market performance. Nevertheless, over the year, fixed interest has failed to provide the usual diversification benefits to a Balanced Portfolio (60% Equities and 40% Fixed Income). Many Balanced Portfolios around the world delivered negative returns in 2018 and failed to beat Cash.
  • Volatility has increased. Research by Goldman Sachs highlights this. In 2018 the US S&P 500 Index experienced 110 days of 1%+ movements in value, this compares to only 10 days in 2017.

 

Happy investing.

 

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.