JP Morgan Asset Management is forecasting returns for a 60/40 US stock-bond portfolio to fall 10bps to 5.4% and believes investors will have to explore alternatives to add income, although not all investors are on board with the asset manager’s suggestion that private equity is a good fit for clients with a high risk tolerance.
The asset manager’s latest long-term capital market assumptions, which predicts the fate of asset classes for the next 10 to 15 years, urges investors to rethink their asset allocation, especially to fixed income, in a world of ultra-low bond yields and modest global growth.
Speaking at a JPMAM market outlook event, chief market strategist EMEA Karen Ward (pictured) explained central banks will have to work considerably harder to get nominal growth to a desirable level while the signs for inflation that usually signal the end of the cycle are still relatively absent.
Investors can do better than the forecast returns on 60/40 portfolios
JPMAM’s projection for global CPI over the next 10 to 15 years is 2.2% and it expects real global growth to average 2.3% over the period, down 20 basis points (bps) from last year’s forecast. It cites ageing populations as a key headwind, while a technology-driven boost to productivity represents the main upside risk.
“That does leave us in this lower-for-longer environment and that’s a tremendous challenge for fixed income returns,” Ward says. “Stocks, therefore, look considerably more attractive in terms of returns.”
JPMAM is optimistic on global stocks over the next 10 to 15 years, predicting the average return to rise 50bps from last year’s prediction to 6.5% in US dollar terms. The forecast for developed markets is 5.7%, and for emerging markets it is 8.7% in local currency terms.
But returns are expected to be muted compared with long-term historical averages. US equity, for example, saw a 9.8% average return over the past 25 years, almost double JPMAM’s prediction of 5.6% over the next 10 to 15 years.
“We just have to do better than that [60/40],” Ward says in response to the 5.4% predicted returns for such portfolios. “We have to add in other alternative asset classes in order to make sure we’re delivering the best risk-return we can.”
Private equity touted for thematic exposure
JPMAM head of global multi-asset strategy John Bilton believes private equity in particular may offer a better environment for innovation and growth, and the firm’s 10 to 15-year aggregate return forecast has been raised 55bps to 8.8%. JPMAM argues the asset class continues to be attractive to those investors looking for return uplift, as well as those seeking more specific exposure to technology themes.
“If you want to push out a bit further along the risk spectrum… it’s the alternative financial markets, which actually hold up relatively well,” Bilton says. “The returns available across private equity are actually relatively good against the historic context.”
Private equity has caught investors’ attention of late as companies opting to remain private for longer are creating opportunities for fund managers operating in the unquoted space. The median age of private companies was seven years in the ’80s and it’s now 12 years on the back of growth of the venture capital and private equity industries.
Investors have, however, been approaching unlisted assets with caution in the wake of the Woodford Equity Income fund blow-up.
Bilton accepts there is concern over the amount of dry powder private equity has on its books, but argues the opportunity available through technology, the greening of the economy and other initiatives that private equity is backing, more than outweighs that dry powder.
“As a result, the alpha trends in private equity have been surprisingly stable over the past few years,” he says.
Where to find opportunities in fixed income
For Psigma Investment Management, the answer to the low yield conundrum is not to bump up the weight to alternatives where head of investment strategy Rory McPherson says it generally struggles to find attractive investments. Private equity does not appear in portfolios because the team views it as too illiquid.
Psigma is forecasting an annual return of just 4.5% for developed equity, albeit over a shorter time frame of five years. McPherson says essentially the firm’s view is “the US is quite expensive and the future returns are quite low”.
Psigma prefers to “think differently” which means owning higher yielding credits with short durations and flexible mandates, going overweight better valued parts of equity markets and having exposure to real assets, McPherson says.
“We do this by setting up bespoke funds with fixed income houses such as Twentyfour and Semper; whose products range between yields of 2% and 9% at the moment with extremely low exposure to rising interest rates. In addition to this, we have an allocation to real assets such as listed infrastructure and commodities which we believe have attractive return potential.”
Similarly, private equity doesn’t register highly on Coutts’ radar. Senior multi-asset portfolio manager Jeremy Ward says the team has reduced exposure to other alternatives including property and absolute return strategies because it’s less positive on the value they offer the portfolio.
Coutts trimmed UK property exposure across the portfolios when the team took profits following a good run last year, rather than issues related to Brexit or liquidity, says Ward. UK direct property was the best-performing IA sector in 2018, returning 3.8%.
But JPMAM’s Ward highlights European property as a source of income compared with the yields on fixed income assets. She notes the yields have come down in both triple-B corporate credit and government bonds but not in Europe ex-UK property (see chart).
On absolute return, Coutts’ Ward says some of the “supposedly market neutral funds” have underperformed quite substantially, which is outside what they expected over the past year and a half.
“I think some of those strategies were multi-factor long/short strategies. They didn’t do very well as there were longer-term traditional correlations that worked since ’08 and those have broken down. That’s what caused some underperformance.”
How to pick a private assets manager
JPMAM emphasises the importance of picking the right managers in private markets with Bilton noting a wide spread of manager returns, of more than 10%, for the large-cap private equity space between bottom and top-quartile managers (see chart below).
He says: “The reality is that investors such as us, if we’re moving into these private markets to seek this additional return this additional beta, what we’re also having to do is ensure that we are appropriately skilled in manager selection.”
JPMAM’s Ward also warns on risk, using the over-used phrase: “There’s no such thing as a free lunch.”
“It’s about understanding what that risk is. Is it capital risk? Is it income risk? Is it liquidity risk? Let’s not pretend at all, that anything that’s offering a different additional return doesn’t come with additional risk.”
