Aberdeen’s Economic and Thematic Research team regularly updates its view of long-term investment returns. This is used as the basis for strategic asset allocation by some of Aberdeen’s largest clients and in particular within our own Diversified Multi Asset funds. Previously, these views have been communicated privately to clients. For the first time this year we are publishing them in the form of a detailed Long-term Investment Outlook.
We hope this report will contribute to your understanding of our views.
You can watch a brief video message in which Craig Mackenzie, a Senior Investment Strategist in the Aberdeen Solutions team, outlines some of the key aspects of long-term economic and investment outlook and the asset allocation implications.
Long-term economic context
Shrinking working age populations in many countries, coupled with weak productivity growth, suggest trend global GDP growth will remain sluggish. Interest rates are likely to see a modest cyclical upswing, but slow growth and the global savings glut look likely to keep bond yields below their pre-crisis levels for some time to come.
Risk ScenariosThere are considerable uncertainties in the near term (see chart above). Will the Republicans manage to introduce the large tax cuts proposed? How aggressively will China’s authorities rein in credit growth? Will political shocks derail Europe’s strengthening recovery? What form will Brexit take? Answers to these and other questions will materially affect return outcomes.
Our long-term view is that equity returns – at around 5% pa - will be weaker than they have been in recent years. Valuations in developed markets are now elevated and our long-term forecasts are for sluggish growth. In the near term our favoured region is Europe, where we think the business cycle has further to run and profit margins more room for expansion. Though, if the Trump administration is able to get its corporate tax cuts through Congress, the US may again prove attractive. Emerging markets are relatively inexpensive. Though the risks of a material slowdown in China, suggest allocations to India and other countries with a strong domestic growth story.
While bonds yields are higher than they were in 2016, they remain near historical lows (see chart above). Low starting yields make for low long-term bond returns. So our bond return forecasts remain extremely low – with the global average return of only 1.4% pa. In the short-term we expect higher short-dated yields in the US, but we don’t expect as much movement at longer maturities, partly due to ongoing Quantitative Easing in Europe and Japan. The big picture is one of structurally low equilibrium interest rates, which suggest that low bond returns look here to stay. It’s hard to pick a preferred region. Returns in Europe and Japan are particularly low. The US is marginally more attractive – though less so after currency hedging costs are taken into account.
Property has delivered strong returns for several years. Relative to government bonds, the yields offered by property are attractive in many markets – the exception is the US, where the gap has closed. Retail property is a major component of property indices. The existential threat to this segment from internet retail is a structural risk for property investors and suggests a more selective approach to the asset class. UK property also must contend with Brexit risk, with its risks to the UK economy and especially the London office market.
Returns from listed alternative assets are particularly compelling for investors facing low bond yields and mediocre expected equity returns. This asset class is growing fast (see chart above). We like infrastructure, asset backed securities and insurance linked securities. These assets offer diversification from equities, relatively low risk and higher returns than developed market government bonds. Though it is important to note that with these asset classes, the choice of vehicle makes a big difference to investment outcomes.
The dollar is now expensive using standard equilibrium exchange rate models. The gap in interest rates between the US and other DM economies will keep it strong in the near term, but over the long-term we expect negative currency returns for European investors in US assets. GBP, EUR and JPY are all cheap on an equilibrium exchange rate basis. We expect them to strengthen in the long-term. Sterling’s fate is heavily linked to the eventual form of Brexit. A disorderly Brexit could see sterling weaken further. EM currencies are, on average, cheap vs the dollar and around fair value vs other developed currencies.
The US credit cycle is now mature. Yet US credit spreads are still tight, offering a small premium for bearing credit risk. In addition, the (gently) rising government bond yields we expect will erode returns, particularly for longer-duration investment grade bonds. Our returns forecasts are modest (2.7% IG, 4.0% HY) – and a lot lower than a year ago, when spreads were much higher. Our favoured credit asset is senior secured loans (4.3%). Loans have floating rate coupons, so are insulated from rising interest rates, and offer relatively high yields.
Emerging Market Debt (EMD)
Emerging market government bonds are a relatively attractive asset class – particularly the local currency variety. Yields are currently at the high end of their range (6.3%) offering strong income return. With one or two exceptions, most of the emerging market economies covered by the standard EMD local currency index are in good shape, with solid growth, controlled inflation and low government debt levels. Currency risk is an issue for local currency EMD, but on average, local currency is now fair value, so for long-term investors there is no longer a structural currency risk.
Asset Allocation Overview
Low expected returns for government bonds means that the traditional ‘balanced’ equity-bond model is no longer the best option for many investors. Our multi-asset portfolios increasingly look to diversify their equity exposure by allocating, instead, to EM debt, loans, asset backed securities and listed alternatives. As the chart above shows, these assets offer much higher returns than government bonds, but with lower risk than equities. They also have low correlations with each other, allowing for more diversified portfolios.
The full Long-term Investment Outlook report can be accessed here.
Past performance is not a guide to future returns. The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
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