Learn to live with the new realities
The era of double-digit investment returns being the norm is over. You will have to adjust your expectations and your investment strategy if you want to cope with the ‘new normal’. Laura du Preez reports
ECONOMIC GROWTH AND INVESTMENT MARKETS WON’T REVERT TO HOW THEY WERE BEFORE THE CRASH
A new investment world has dawned in which you will have to save more, work longer or revise your retirement lifestyle, or all three, the managing director of one of the world’s largest investment managers told the unit trust industry this week.
Paul McCulley, the managing director of Pimco, the United States-based global manager of more than US$1 trillion, conveyed this bad news at the Raging Bull Awards ceremony in Cape Town.
McCulley was the guest speaker at the ceremony, which celebrated the success of local unit trust funds and fund managers who have made money for their investors over the past three to five years.
Speaking after a year in which equity markets around the world made a good recovery following what he termed “a cardiac arrest” in 2008, McCulley warned that if you think the investment world has returned to normal, you are wrong.
Many people thought that 2008 was a nightmare, and after last year they think the nightmare is over, he says.
But like a heart attack victim has to adapt his or her lifestyle after such an event, investment markets will be different after the credit crisis, and a “new normal” will prevail, McCulley says.
You should not engage in wishful thinking about returning to the old normal. The investment world is different now, and the era of earning double-digit investment returns of 10 or 11 percent is over, he says.
Returns in the next three to five years will be in single digits: five, six or seven percent, he says.
The old normal was characterised by deregulation, globalisation and leverage (borrowing to invest), McCulley says. More and more economic activities became part of the capitalist system without government regulation, and this enabled more activities to be financed with borrowed money (leveraging), he says. “These were tailwinds for economic growth and investment returns. It was fun.”
But, McCulley says, the problem was that we did not know when to stop. As a result, between 2002 and 2007 bubbles developed in the property market and the equity market.
The US property market bubble grew as financial institutions gave loans to people who could not really afford them, without requesting down-payments on properties and without proof of the lenders’ income or ability to repay the loans. The belief was that rising property prices “would cover all sins”, because loans in default could be refinanced as house prices rose, McCulley says.
He says the loans were packaged as investments and passed on through the financial system, causing other asset prices to become over-inflated.
When high loan defaults exposed the losses on sub-prime loans, it started what McCulley calls a global run on the financial system.
“The underage drinking party at which the rating agencies Moody’s and S&P handed out fake identity documents ended in tears,” he says.
FROM TAILWINDS TO HEADWINDS
McCulley says the new normal will be to reverse the three things that provided the tailwinds under the old normal.
The new normal will therefore involve reregulating, deleveraging (reducing borrowing) and pulling back from globalisation, he says. “This will provide headwinds for economic growth for the next three, five or seven years.”
McCulley predicts that as a result economic growth in the developed world will be about four percent. He says you should expect that companies will produce market returns at a similar rate.
A slow-down in economic growth in the developed world will, by implication, mean slower economic growth in the developing world, McCulley says.
Emerging markets did a great deal of piggy-backing on the economic growth of the US, he says, and they will have to work harder in future to keep growing their economies on the back of their own homegrown consumerism.
Bond yields will be about three or four percent, McCulley says, and the best yields will be from bonds in the developed world, where growth and hence interest rates will be weak. Rising interest rates are generally bad for bond yields.
McCulley says some investors still mistakenly think they will get more good returns when markets rerate and the priceto-earnings ratios of shares (the shares’ prices divided by their earnings – indicating how expensive the shares are) rise rapidly. But, he says, we have already had those good returns this past year, when market sentiment improved from expecting Armageddon to accepting that the global economy was still functioning.
“And you can’t go to heaven twice for the same good deed,” he says.
McCulley says the new normal may spawn new investments. In particular, he expects investments with benchmarks that will reflect the greater role of emerging markets and investments that include more asset classes, such as commodities and private-funded (rather than government-funded) infrastructure.
Investors now realise that, in the market crash of 2008, equities and corporate bonds both suffered, and investors did not benefit by being diversified across these two asset classes, he says. Investors will now look more to managers to understand the risks and allocate their portfolios in a way designed to minimise those risks.
Finally, McCulley says, investors are realising that with globalisation and a less US-centric world, the market disasters – such as the Russian, Mexican, Brazilian, Asian and 2008 crises – that they expected would happen only once every 100 years are happening more frequently, and perhaps investors need to have investment insurance against these disasters.
New products for the new normal may offer you some ways to protect your investments, but they will not be able to give you the high returns of the old normal.
You must therefore adjust your expectations and plan to save more, work longer or revise your lifestyle in retirement.
You should accept this, make your plans and get on with your life, McCulley says.
PAUL McCULLEY: Things won’t be what they used to be.