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

Weekend Argus (Saturday Edition) - - GOODHANGOUTS -


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.


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.

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