How are you seeing traders execute the strategies that you are recommending?
The next five years will deliver an economic environment that will alter the dynamics of equity, bond and foreign exchange in several ways. Equities will struggle to repeat their stellar performance of the past few years. In absolute terms, stocks in the MSCI World Index will generate a reasonable return of some 7% per year in local currency terms over the next five years.
But relative to corporate bonds, our calculations show they will deliver an excess of return of just 1% per year versus around 10% over the past five years – and this for roughly two times the risk. This means fixed income will offer a more favourable risk-adjusted return than stocks. Investors should, then, allocate more to fixed income and especially corporate bonds. We think the dispersion of returns across regional and national equity market will fall. Equity investors, therefore, may find it more rewarding to invest along sectoral or thematic lines. The foreign exchange market will be defined by a steady but persistent depreciation of the US dollar. On a trade-weighted basis, we expect a decline of some 2% per year through to 2029. Assets that are negatively correlated to the dollar should account for a larger share of portfolios.
What are the key macro themes that impact the strategies you are recommending to investors?
The global economy rests on less robust foundations compared with the days when interest rates and inflation were both heading lower and international trade was booming. Productivity is unlikely to rise much over the remainder of this decade as globalisation stalls and businesses struggle with the growing costs of the net zero transition and labour shortages. Consequently, we expect only modest GDP growth of just 2.6% at a global level in real terms over the next five years, just below its long-term average.
Making matters potentially more complicated for investors is the likelihood that moderate growth won’t translate into moderate inflationary pressures. We think inflation should also prove a stubborn foe; while it will eventually settle within central bank target ranges by the end of this decade, it will be more volatile than policymakers would like.
What key factors do you look at when creating your strategies?
Macroeconomic forces have a bigger influence on asset class returns over the medium and long term than any other factor; understanding how the economic landscape changes over time is both a fundamental component of strategic asset allocation and crucial for investment success over the long run. Over the short run, markets are more volatile than is warranted by underlying economic conditions. Moreover, the relationship between asset classes is not stable through time.
This leads to a mispricing of assets, which presents opportunities for tactical asset allocation. Every asset class carries a risk premium, which rises and falls as the business cycle progresses from one phase to another. The focus of our research is to identify how the macroeconomic environment is changing and how this is likely to affect the risk premium attached to each asset class. The skilled deployment of both strategic and tactical asset allocation can deliver superior investment returns over the long term.