Risk-return trade-off doubts after underwhelming results
With growth assets having disappointed in the recent past it is understandable that some investors may be despondent, but only looking backwards may lead to the wrong conclusions, according to Pieter Koekemoer, head of Personal Investments at Coronation Fund Managers.
He says recent experience has planted doubt in the minds of some investors as the riskreturn trade-off did not hold.
“Over the five years to the end of May, investors achieved no additional return when increasing risk incrementally. Regardless of whether you invested in a low-risk money market fund, a fully invested equity fund or anything in between, your average return outcome would have been similar,” he says.
“The issue is amplified when you assess returns over three years. Over this period, investors were better off in money market funds than in equity funds — you experienced the risk, but not the return.
“This inevitably leads some investors to ask questions: is it still worth exposing my portfolio to risks associated with growth assets? Should I rather derisk my portfolio? Or put simply: where did my return go?”.
Coronation recently concluded its second annual client survey in which it used the opportunity to ask investors questions that could help create better outcomes for clients.
“One of the areas that we focus on is the expectations gap — the difference between investors’ expected returns and their actual experienced returns. The results can be interpreted as a barometer for how comfortable investors are about their investment choices.
“On average, those investing for short-term income expect an annualised return of 9%, compared to the actual outcome of 8% and 7% per annum over three and five years, respectively, of the average flexible fixed interest fund.
“In contrast, those investing for growth over the long term have endured a much more disappointing experience over the past few years.
“Our survey shows that the average long-term investor expects 12% per annum. Compare that to the average return of your typical balanced fund of only 4% and 7% per annum over three and five years respectively.
“Although one can argue that investor expectations are too optimistic and require moderation to be prudent (at the current 4.4% CPI rate, it implies a 7.6% per annum real return expectation, compared to a 5% real return as the generally accepted reasonable expectation for a balanced fund), the reality is that the average balanced fund has only delivered a third of the expected return over the past three years.
“Unfortunately, this expectation gap may be interpreted as justification for taking actions that could prove to be wealth destructive over time,” warns Koekemoer.
The danger of basing your decisions only on personal experience is that you are ignoring 99.9% of the available information. Coronation’s full historical record (of nearly 1,000 observations), show the following about local share investors with 10-year investment horizons:
● South African shares on average returned inflation +8% per annum since 1930;
● The average return since the advent of democracy in 1994 is actually higher, at inflation +10%;
● Over the past 36 observations since July 2015, the return declined to inflation +5.6%;
● The return achieved exceeded inflation about 90% of the time since 1930, and 100% of the time since 1969;
● Longer-term returns tend to mean revert: lower return periods tend to be followed by higher return periods and vice versa.
There is no doubt that the risk-return trade-off has held over time. “Since 2013, we have consistently cautioned investors to expect more muted returns,” says Koekemoer.
“At the time our view was driven by the lofty valuations of South African assets as well as our assessment of investor expectations on the back of extrapolated past returns.
“What is important now is the view going forward, and in many ways it is more promising. Risk and reward are intrinsically linked, and we are concerned investors are diluting their ability to participate in the trade-off due to the experience of the recent past.
“One’s expected return increases as past returns remain lower for longer indicating opportunities that can result in improved returns in future,” says Koekemoer.