Markets are facing an “evolution, not a revolution,” and asset returns are likely to improve over the next ten years, despite a range of challenges facing global markets, argued Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions.
For 10 to 15 years the traditional balanced investor has seen fixed income delivering “return-free risk,” despite being a significant portion of the portfolio, said Tollette, in a lively panel discussion at Conexus Financial’s Fiduciary Investors Symposium held in Singapore. Tollette’s projections clashed somewhat with those of Craig Thorburn, director, CIO’s office, at Australia’s Future Fund.
“At a broad level, we see fixed income, because of concerted and coordinated central bank activity, in decent shape for the first time in a long, long while,” Tollette said.
Every year Franklin Templeton Investments holds a formal, forward-looking exercise that brings together asset class experts from across the firm, including quant equity teams, to give a ten-year capital market expectations forecast. The exercise uses a mean variance optimisation framework as a starting point, then brings in expert views to make it more forward-looking and cover variables that are harder to predict, Tollette said.
Despite some “scary” global developments taking place in the geopolitical sphere, Tollette said “over the long term I’m pretty positive on returns, with perhaps even a lower-risk portfolio meeting a lot of investors’ expectations over the next ten years”.
Tolette said that in the 1980s a relatively low-risk public pension portfolio with a 30-70 split of equities and fixed income respectively, was able to achieve its desired rate of return without increasing risk. But for the next 35 years, this portfolio had to add risk to achieve its desired returns, Tollette said.
A cool new normal
Times have again changed, and “for the first time in many years, what I’m seeing, looking at our forward-looking ten years, is many plans are going to be able to achieve that rate of return, 7 or 8 per cent, without adding risk,” Tollette said. “That is a cool new normal.”
Inflation pressures “are likely to continue a little bit” and inflation may move slightly higher, but the firm has a low level of conviction around this because demographics are “pulling in the other direction, there are going to be fewer people buying most of the stuff in this world and driving inflation–at least goods inflation”.
However there could be continued developed market inflation pressure on services, wages and shelter which is proving to be “sticky”, Tolette said.
Asset risk premiums rose in 2022, he said. “It’s just simple math right, when markets fall 25%, forward looking returns look better, and we see that almost across the board.”
The main difference in the coming years is that policy makers will be more constrained, particularly on the fiscal side.
“US is nearing its debt levels,” Tolette said.
“It really can’t continue to do that and expect to be the worlds reserve currency, it can’t continue to borrow like it has been.
“And many other countries are in a similar spot. It’s going to be harder for many developed governments to respond [with fiscal levers] in the same way.”
But broadly speaking, markets are predicted to be in better shape, he said. “So a typical 60/40 portfolio from the last several years has returned a heart breaking 3.8%,” Tollette said. “That was our expectation last year. Now that same portfolio is closer to 6%. It’s doing much better.”
Private assets will also see positive returns, but the caveat is “we assume in these returns that you are able to avoid the bottom quartile of managers in private assets”, Tollette said.
“That’s a big assumption,” he said. “If you don’t do that, if you cannot avoid the bottom quartile of private asset managers, you shouldn’t invest in private assets at all.”
Returns much more challenging
Craig Thorburn, director, CIO’s office, at Australia’s Future Fund, was less sanguine. Thorburn said markets are facing a new paradigm which will make returns much more challenging in the years ahead, due to issues such as de-globalisation, demographics moving from a tail to a headwind, policy and political populism, inflation, and the role of bonds in portfolios.
Thorburn said the Future Fund has been increasing its bonds exposure over the last six to nine months, seeing them as a defensive anchor in some scenarios like a “traditional downturn”, but not necessarily in an environment of geopolitical tensions and coordinated fiscal and monetary pressures on the economy, which is forcing investors to “consider aspects that are non-traditional”.
“Our concern is that in that environment, bonds may not be the anchor that you may have relied upon for last 20 to 30-plus years, particularly when you consider that in that environment there has been the fantastic tail wind of declining nominal yields,” Thorburn said. “We’re just not so sure that is in our future gong forward, even though pricing today is definitely better than it was, say, a year ago.”
The Future Fund has looked to other asset classes like alternatives, in particular hedge funds, which it sees through a defensive lens. If investors can avoid the bottom quartile for hedge fund investments, they can achieve uncorrelated returns, Thorburn said.
“We’ve been fortunate enough to have had that happen to us in the last year or so,” he said.
“There have been incidences where that hasn’t occurred, but over the long horizon, we’ve been very fortunate in our manager selection, that we can say hand on heart, that asset class, alternatives, hedge funds…that’s worked really well for us.”
Private debt is also providing some “interesting alpha opportunities,” and providing a lot of value to portfolios, he said.
“It may not be overly defensive when you look at some of the exposures you may need to have,” he said, “but it’s an important part of what we will consider to be more resilient or stronger allocations.”