Returns: Susan Hely Plan for managing uncertainty

Our 10-point strategy will help investors get through what looks like another tough year

These are unusual times for investors. The International Monetary Fund says growth is below average for the sixth consecutive year. “The world is in a malaise. It is a very unusual period,” says Chris Probyn, global chief economist of State Street Global Advisors (SSgA). “And 2017 is not going to be any different.”

The era of record low interest rates and monetary easing is coming to an end, says Probyn, who is anticipating at least a few interest rate rises in the US this year. Inflation is emerging after a long absence and the US dollar is expected to rise, particularly if corporate tax rates change.

“A general feeling of unsettledness is reflected in many questions I’ve been getting from clients in recent months,” says Bill McNabb, CEO and chairman of Vanguard.

“There are plenty of question marks over the global economy as the UK prepares to implement Brexit, the Trump administration rolls out its policies, central banks in Australia and elsewhere shift their thinking on monetary policy and interest rates, and growth – especially in China – continues to worry market watchers,” says McNabb.

What can investors do?

1 LOWER EXPECTATIONS

No one is expecting double-digit returns this year. Vanguard’s outlook for global stocks and bonds remains the most guarded in 10 years. Investors should be realistic but not pessimistic about portfolio returns, says Jeffrey Johnson, head of investment strategy group at Vanguard Asia-Pacific.

Vanguard has downgraded its long-range equity returns for the next 10 years from 7%-10%pa to a more guarded 6%-9%pa for Australian and global equities. It makes the point that the long-term outlook is not bearish and can even be viewed as a positive when adjusted for the low-rate environment. Its prediction for bond returns is 1%-3% pa.

If you see investments offering high returns, do your homework.

2 SPREAD YOUR BETS

“We have hit the buffers. There is nowhere to go,” says Rick Lacaille, global chief investment officer from SSgA, referring to the lack of asset classes that offer great returns. It is important to be diversified across different asset classes.

Vanguard’s McNabb says that because his portfolio is fully diversified, it always contains something that underperforms expectations. “But there are almost always surprises on the upside too. This is the power of diversification and a ‘secret’ to investment success,” he says.

Which ones does Lacaille favour? “We are long on equities,” he says. He believes there is more strength to come from US markets in spite of the rally making their stocks expensive. “The US equity market is the one we like. It is expensive but it has earnings growth potential,” he says.

Lacaille is overweight real estate investment trusts (REITs). He is neutral about emerging markets.

Lacaille favours investment-grade credit instruments and warns against lower-grade junk bonds because

defaults are increasing. SSgA head of investments in Asia Pacific Kevin Anderson says, “We like goodquality, B-grade junk bonds.” He says that 2016 was a tough year for stock pickers, both globally and in the US.

3 PREPARE TO WORK HARDER

“10 years ago it was a lot easier to generate 7% return. But to get 7% in 2017, you have to do a lot more,” says Anderson. “You have to put more factor tilts, more private equity, emerging market bonds and high yield bonds.” He says instead of leaving 30% of your portfolio in fixed income and 70% in growth assets, you need to get a better return from your core investments and add in more asset classes.

4 SEARCH FOR INCOME

“Income is still the biggest asset,” says Lacaille. Relative to bond yields, dividends from equities still look attractive. He says that globally the priceearnings multiples of high-dividend equities have come down since 2016.

“Look for dividend yield sustainability,” he advises. The Australian economy has the mildest economic recession from the GFC. “2.4% growth in Australia is something that Europe and Japan would kill for,” says Probyn.

But there are worrying signs for investors, such as a weakening housing sector, a sluggish mining outlook, slow wage growth retarding consumption and the big government deficit, he says.

The Australian sharemarket is in the enviable position of providing a dividend yield, including franking, of around 5.7% for the ASX 200 index.

5 FOCUS ON THE LONG HAUL

Stick to a long-term investment plan and don’t get distracted by the short-term noise. “The problem with these natural inclinations is that they can make us forget about our long-term investment plans. That’s never a good thing,” says McNabb.

Discipline is crucial over the next five years, as they are slated to be more challenging for investors than the previous five, says Johnson.

6 KEEP FEES DOWN

Minimise your investment costs in a low-return environment. A 2% fee can really hurt a return of 4%. Understand the fees you are paying and whether you are getting value for money. Annual fees to cover investment management costs can vary from fund to fund and are best kept to a minimum. Fee differences have little, if anything, to do with the quality of investment management. The annual fee is usually deducted regardless of circumstances. If the asset class, or the manager, or both have a bad year, you still pay.

7 REBALANCE YOUR PORTFOLIO

If you hold your own investments, one golden rule is to rebalance consciously. It keeps your exposure to shares on a steady course.

Most investors have a target asset allocation that divides how much they hold in shares and defensive assets. But asset allocation gets out of kilter fairly easily because no asset class stays the same forever. For example, when the market zooms higher, the typical 70:30 ratio changes and your shares may be worth 75% of your portfolio. You’re feeling wealthier. But you are also in a riskier position. If the sharemarket crashes, you’ll lose more.

“In investing, there is always going to be uncertainty – and a little pain,” says McNabb. “It’s difficult to continue to invest in a tumbling market. Likewise, short-term noise can tempt us to not rebalance on a regular basis. Disciplined rebalancing is vital to achieving long-term goals.”

8 MASTER VOLATILITY

In times of uncertainty, it’s easy for investors to make bad decisions, says McNabb. “Markets often respond to surprise events with volatility. We had plenty of those in 2016, and I expect similar marketrattling events to occur this year.”

Lacaille expects news to cause much bigger shocks in 2017. But so far in 2017 volatility has been low according to the CBOE Volatility Index, known as the VIX Index.

“Some investors may interpret volatility as a sign of trouble and flee to whatever they perceive as a safe haven. Others may see buying opportunities at every turn.”

9 HOLD SPARE CASH

Keep some money for the market dips. It could be a good time to buy.

10 WHAT REALLY MATTERS

There is so much distraction on the political front, particularly with Donald Trump in the US and the European elections. But does it really matter to investors? Be careful in predicting how markets might respond. Often markets react in a different way to what was anticipated. In 2017, there are three important themes, says Anderson. They are income, growth and protecting your money.

Investors should be realistic but not pessimistic about portfolio returns