Investors will face tough challenges in the coming years, according to Pimco. While volatility will remain high due to the presence of numerous potential ‘disruptors’, return prospects have never been lower.
Where investors enjoyed high returns and little volatility in the past five years [until the corona crisis], it will be the other way around in the next five years’, said Pimco’s chief economist Joachim Fels’ in a press conference with European journalists. The reason is the high valuations for most investments combined with an ailing economy and a lot of macroeconomic uncertainty.
Stakeholder-led
Northern Trust, which published a five-year outlook around the same time as Pimco, is just as pessimistic. ‘We also expect an environment of high volatility and low returns,’ said Wouter Sturkenboom, investment strategist EMEA & APAC at the asset manager, in conversation with Investment Officer. Although the continuing low interest rate environment is favourable for valuations of (growth) equities, this is the only ‘silver lining’ he sees. ‘We expect a change from a shareholder-centred world to one in which more attention is paid to other stakeholders, such as employees,’ Sturkenboom noted.
Pimco’s Fels expects a similar development. ‘The share of corporate profits in global GDP has grown almost continuously over the last 20 years, but we expect that trend to be reversed now, with social considerations becoming more important for companies. This comes at the expense of profit maximisation.’ And that, coupled with the weak economic growth prospects partly due to the corona crisis, of course has an impact on return expectations. ‘We have almost halved our expected return forecast on a 60/40 portfolio, from 6.3% over the past five years to 3.6% over the next five years,’ said Sturkenboom.
The outlook for bonds is also bleak. ‘We have seen a radical shift towards an activist, expansionary fiscal policy. The large financing needs of governments make it impossible for central banks to raise interest rates again and will inevitably lead to more quantitative easing,’ he said.
Range-bound bonds
As a result of this permanently low interest-rate environment, bond yields will be range-bound in the coming years, Fels believes. ‘There is a risk of a rise in inflation if fiscal policy remains too broad for too long, but I expect central banks to put a limit to any rise in yields.’
On the other hand, interest rates may also fall further, although of all developed markets that chance is only real in the US because government bond yields there are still positive. ‘That is also the main reason we have a preference for Treasuries over euro area government bonds,’ said Fels.
In corporate bonds, Pimco still sees opportunities for return, but the asset manager does not advocate an overweight to the category. ‘This is not the time to take a broad allocation to credits. There is a good chance that defaults will increase and there are many losers from the climate crisis in the indices. Active management is therefore absolutely essential.’
Northern Trust is a little more optimistic in that respect. The asset manager even expects a higher return on high-yield bonds than on equities. ‘We are not as worried about rising insolvencies as the market. It may be that the share of zombie companies is rising, but that is not a foregone conclusion. History has shown that the majority of zombie companies eventually manage to get healthy again. Moreover, investors are now very cautious: real accidents tend to happen at a time when there is euphoria in the markets.’
Investors remain in a difficult position, however. ‘Some will want to take more risk because of the downward revision of the yield outlook, but at the same time they face higher volatility. So that’s a difficult choice,’ Sturkenboom outlines the dilemma that investors are struggling with. In part, a higher allocation to private equity at the expense of listed shares can offer a solution. ‘Despite the rises in valuations, we still expect an over-yield of 300 basis points,’ said Sturkenboom.