A changing rate environment
Institutions generally regarded interest rates and bond yields as "low". This is not surprising; global bond yields reached their lowest levels in recorded human history in July 2016. We have learned that when the world's central banks buy several trillion dollars of government securities amid a backdrop of weak global growth and feeble inflation, they can drive yields down. Now that the Federal Reserve has begun its policy of normalization, both increasing short-term interest rates and reducing its balance sheet, with the European Central Bank (ECB) following in due time, yields can logically be expected to move somewhat higher.
But this transition is not only likely to affect bond values; it could also affect every asset value. Stocks, real estate, loans, private equity, all have "present value" as their underlying valuation metric – the discounted present value of future expected cash flows. All of these will be re-calculated in a higher yield environment.
So why do institutional investors on average target investment returns exceeding 7% over the long term? This yield is nearly double the recent trend growth rate of nominal US GDP. The interest rate environment that has been a tailwind for returns in the past may be a headwind in the future.
Other potential challenges
Additional investment return challenges might include:
- Sluggish reported growth of global productivity
- The systematic rise in income inequality, implying that more income is saved and less consumed
- The rise in monopoly/oligopoly profits as a share of total corporate earnings
- Demographic aging and weaker consumption in most developed countries including China
- Negative wealth and GDP effects of global climate change and the need to radically adjust existing infrastructure in coastal areas
In general, we agree that current asset values are stretched, but we do not see our way to the institutional return expecations of 7% or more that are reflected in the survey. This appears to be a simple extrapolation of past good news, rather than a bottom-up analysis of future return opportunities. Investors seem to be asking a lot from the robots.
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Risks: All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.
Natixis Investment Managers, Global Survey of Financial Advisors conducted by CoreData Research, July 2016. Survey included 2,550 financial advisors in 15 countries.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.