Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Shares to offer lukewarm returns in hot times
Dutch asset management giant, Robeco, tips a mainly positive, if subdued, outlook for equities over the next five years but with a high degree of uncertainty ahead in a decade it dubs the ‘Roasting Twenties’.
In its new five-year forecast returns paper, Robeco says “we expect risk-taking to be rewarded in the next five years, but judge the risk-return distribution to have a diminishing upside skew”.
“The possibility of outsized gains for the equity markets is still there, but the window of opportunity is shrinking,” the report says.
According to the Robeco “base case” scenario, the world economy should emerge in reasonable shape from the COVID-19 crisis over the next few years despite lingering effects from the virus.
“After the strong growth momentum in 2021, we expect a transition towards a more durable, less exuberant phase of economic expansion, with growth rates in developed economies exceeding those observed during the last expansion of 2009-19,” the paper says. “Very low real interest rates, elevated household wealth levels and higher investment activity would contribute to this scenario.”
However, the manager lays out two other potential broad outcomes ranging from a bullish ‘Silver Twenties’ – where excess savings and easing pandemic conditions converge in a sustainable economic splurge – and the bearish ‘Stag Twenties’.
Under the Stag Twenties scenario “a slowdown in economic growth momentum in 2022 is reinforced by stubbornly high input costs resulting from persistent dislocations in the capital and labor markets”.
“After the burst of stagflation, disinflation emerges due to lower consumption growth, higher taxes, forced deleveraging, rising corporate and household defaults, and a depleted wealth effect as financial markets were dealt a severe blow in the preceding episode of stagflation,” the paper says.
Despite leaning to a more optimistic outcome, Robeco says investors will face some difficult choices between a “a frigid bond market and a torrid equity market” in the coming five-year period.
“We expect asset returns to remain below their long-term historical averages over the coming five years, mainly due to the low risk-free rate and, in some cases, subdued risk premiums,” the study says.
The report plots five-year annualised returns (in US dollar terms) ranging from 0.75 per cent for developed market hedged government bonds to 6 per cent for commodities: developed and emerging market equities should return 5.25 per cent and 5 per cent, respectively, based on the Robeco assumptions.
Victor Verbek, Robeco chief investment officer, says in the paper that expected returns remain a “vital element” of strategic planning and “can be used as input for the investment plans of both institutional and professional investors”.
In a generally upbeat summary, Verbek says the Roasting Twenties title “is inspired by the Roaring Twenties of the previous century in which the Western world saw economic, social, and cultural prosperity”.
“However, there are some crucial differences. Productivity boosts are not a luxury, but a necessity to deal with climate risks, ageing societies, and economic inequalities,” he says. “The urgency of dealing with climate change risks has increased due to the physical risks that have materialized over the past years: severe droughts, increased wildfires, and massive floods.”
And for the first time, Robeco includes climate change in its asset class forecasts.
“Indeed, it is crucial to carefully analyze the impact of climate change, but perhaps the biggest risk of climate change for investors is not seeing the opportunities,” Verbek says.
Robeco, which advises on a NZ Superannuation Fund portfolio among other clients here, reported about €200 billion in assets under management as at the end of June this year.
