Shane Oliver | Nov 16, 2017 07:41
Originally published by AMP Capital h2 Key points/h2
The last five years have seen strong returns for diversified investors thanks to double digit gains in shares (after a rebound from a mini bear market around the Eurozone crisis) and solid returns from unlisted commercial property and infrastructure. For example, balanced superannuation funds saw median returns of 9.3% per annum over the five years to September (after taxes and fees). Despite this our assessment remains that medium term (ie 5-10 year) returns will be constrained because of low investment yields across most asset classes.
Back in the early 1980s the medium term return potential from investing was pretty solid. The RBA's "cash rate" was around 14%, 3-year bank term deposit rates were around 12%, 10-year bond yields were around 13.5%, property yields were running around 8-9% and dividend yields on shares were around 6.5% in Australia and 5% globally. Such yields meant that investments were already providing very high cash income and only modest capital growth was necessary for growth assets to generate good returns. As it turns out most assets had spectacular returns in the 1980s and 1990s and superannuation fund returns averaged 14.1% in nominal terms and 9.4% in real terms between 1982 and 1999 (after taxes and fees).
Since the early 1980s starting point investment yield have collapsed, resulting in slowing 10-year average nominal and real returns for superannuation funds as seen the chart above. Today the RBA cash rate is just 1.5%, 3-year bank term deposit rates are just 2.5%, 10-year bond yields are just 2.6%, gross residential property yields are around 3% and while dividend yields are still around 5.6% for Australian shares (with franking credits) they are around 2.4% for global shares.
h2 Starting point yield matters – a lot!/h2Investment returns have two components: capital growth and yield (or income flow). The yield is the most secure component and generally speaking the level it starts at when you undertake the investment is key - the higher the better. So our approach to get a handle on medium term return potential is to start with current yields for each asset class and apply simple and consistent assumptions regarding capital growth. We also prefer to avoid a reliance on forecasting and to keep the analysis as simple as possible.
Complicated adjustments and forecasting can just lead to compounding forecasting errors.
Source: Global Financial Data, Bloomberg, AMP Capital
Our latest return projections using this approach are shown in the next table. The second column shows each asset’s current income yield, the third shows their 5-10 year growth potential, and the final column their total return potential. Note that:
Combining the return projections for each asset indicates that the implied return for a diversified growth mix of assets has now fallen to 6.5% pa and is shown in the final row.
The assumptions for nominal growth used in these projections allow for several medium term themes: slower than pre-GFC growth in household debt; an ongoing backlash against the economic rationalist policies of globalisation, deregulation and small government; rising geopolitical tensions; aging and slowing populations; constrained commodity prices; technological innovation & automation; rapid growth in Asia and China’s growing middle class; rising environmental awareness; and the energy revolution. Most of these are constraining nominal growth and hence investor returns. However, technological innovation is positive for profits and some of these point to inflation bottoming.
h2 Key observations/h2Several things are worth noting from these projections.
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