Baby boomer bulge will change investment targets and strategies
• Unpredictable markets and misallocation of capital make it dangerous to blindly track indices
Most of us are reconciled to the introduction of index funds into the investment landscape. In SA they may account for less than 5% of equity assets, divided between unit trusts and exchange-traded funds but in the US they account for onethird of mutual fund assets and should make up half by 2020.
So the new book The End of Indexing by Niels Jensen is certainly contrarian, much like those books in the late 1980s predicting the demise of Japan, which at the time had a substantially higher market capitalisation than the US.
Jensen’s argument against index funds is not based on the premise that active managers will all start magically beating the index. Rather, he believes the investment environment will no longer be suited to index tracking. As chairman of Absolute Return Partners, Jensen is no fan of market following investment strategies.
There are six structural mega-trends that will mean the end of the benign conditions for equities and bonds over the past 30 years. Sitting back and waiting for assets to compound just won’t be an option.
The six trends Jensen has identified are the end of the debt supercycle; the retirement of the baby boomers; the declining spending power of the middle class (in the West); the rise of the East; the death of fossil fuels; and the mean reversion of wealth to GDP. As a baby boomer myself I was particularly intrigued that my generation had been singled out. Jensen says it was my (and his) generation turning middle aged in the 1980s and 1990s that was the foundation of the Great Bull Market.
At least in the US there was a substantial baby boom echo around the 1970s as the boomers had their own families, but in Europe and Japan it was more like a baby bust. So the world is rapidly ageing, and by 2100 the proportion of people over 80 will equal the proportion over 60 today.
Jensen points out that this is not just a developed market phenomenon. In emerging markets, over 65s will rise from 387-million to 1.22-billion by 2050. China’s old age population will rise from 12% to 39%.
There is plenty of evidence that ageing will harm economic growth as well as equities and bonds. As older consumers spend less, it should put less pressure on inflation — as it did in Japan.
But Jensen says there are important differences between Japan and the West: it is a creditor nation with a very low immigrant population and low female participation in the workforce.
Jensen points to a report by the Bank of International Settlements, which says in the West old people (and children) consume far more than they produce, which fuels inflation.
It is no coincidence that Germany’s welcoming attitude to refugees comes at a time when the work force is retiring in record numbers. There might not be enough people to keep German industry flourishing without these newcomers. A combination of migration and a later retirement age could delay Europe’s economic crisis.
Jensen says healthcare is likely to grow fastest as a percentage of GDP in the US, even though that country has a younger population than most of the developed world. But, like the private sector in SA, it works on an expensive insurancebased model. It could spend more than 25% of GDP on healthcare and even the best performers in the developed world, Denmark, Italy and the UK, could be nudging 15%.
There are some fairly predictable industries to invest in if you take a positive view of the senior citizens’ boom, including providers of annuity products, retirement homes and cruise ship holidays, or even more adventurous bucket list journeys, driverless cars and limousine services.
And he also expects seniors to take more interest in home decor as they spend a greater portion of their time there.
Not much of the book examines index funds directly, but its title should at least help it sell. There is a chapter, though, on why index investing will dwindle. Jensen says it makes no sense to buy asset classes blind.
It will become apparent that there has been a misallocation of capital in some sectors and countries; he points to China and global property. He says market returns are likely to be modest in any case, as the US Federal Reserve is raising rates, which is not good news for equities. He advises keeping exposure to beta risk — or an index-style approach — low, as markets have become so unpredictable.
He does not buy the argument that institutions must invest somewhere, and only equities are worthwhile these days. Hedge funds used to be popular but they magnify the worst fault of active managers — high fees — and provide increasingly mediocre returns.
Many inefficiencies in the market, such as shares trading at different prices on different exchanges, have disappeared. And of course there remains the possibility of unlimited losses from short positions. But the risk of capital loss can be huge from a blind market investment into vanilla equities — at its worst more than 50% over two years in the US and 70% in the UK.
And you can’t assume that the central banks will bail out the financial system as they did in 2008. Jensen favours quite quirky investments, for instance unlisted credit instruments such as music royalties, leasing and regulatory capital relief, when banks offload part of their loan book to long-term investors.
The one place he is prepared to take a passive approach is Africa, because of the opportunities provided by a young, urbanising population and growth off a low base. Investors can buy an African equity and leave it for the next 10 years.
Jensen doesn’t believe in either alpha or beta, but in gamma. This includes the wellknown factor or smart beta approach. And the big five are volatility, momentum, income (dividends), value and size.
All have proved to work over time, but will they continue to work in what looks like a tough new environment in the West, though not in Asia and Africa?
INVESTORS CAN BUY AN AFRICAN EQUITY AND LEAVE IT IN THE BOTTOM DRAWER FOR THE NEXT 10 YEARS