2017 and the search for returns: the low-return imperative
How low will returns be in 2017?
We believe the search for returns in 2017 is not going to get any easier against a backdrop of high U.S. equity prices, narrow credit spreads and low bond yields.
The election of Donald Trump as U.S. president has thrown an extra element of uncertainty into our global economic outlook. We believe markets are assuming the new administration will have a policy mix that will boost growth, equities and the U.S. dollar (tempered modestly by recent presidential tweets), as well as push the U.S. Federal Reserve (Fed) into more rate hikes this year.
Yet, there are still uncertainties about the new president's views. For example, some of his campaign comments about withdrawing from trade deals and imposing tariffs on China, if enacted, have the potential to send the global economy into a renewed downturn. The post-election optimism driving markets in late 2016 could quickly reverse.
The market environment is also creating huge challenges that necessitate change. Specifically, our 2017 capital markets forecasts in our annual Global Market Outlook are calling for very low returns across asset classes over the next seven to ten years.
I believe that this challenging environment helps to create a simple low-return imperative for investors: When expected future market returns are likely to be lower than the required rate of return, we believe an investor cannot afford to ignore any investment strategy that may offer incremental return, take on risks they do not expect to get paid for or disregard implementation efficiency.
With this backdrop, we believe investors should respond in three ways:
- Diversify sources of returns
- Use a robust dynamic asset allocation process to guide tactical positioning
- Seek effective implementation capabilities.
Regarding diversification, investors may be wise to consider a multi-asset approach that includes exposures to a wide variety of return sources. The typical U.S. investor may have a home-country bias and, from our view, non-US equities look slightly cheaper. We also believe that, with reflation, having real estate, infrastructure and even a very small allocation to commodities may make sense.
In terms of dynamic asset allocation and tactical positioning, Russell Investments’ strategists are keeping a keen eye on opportunities in emerging markets. This asset class was hammered after the U.S. election on Nov. 8, 2016.1 However within this category we think there are opportunities in select countries’ equity, bond and currency markets. We also view value stocks as a reasonable overweight, despite that segment’s run in the second half of 2016.2 Niche strategies that also look attractive to our team include bank loans, which are less sensitive to rate increases, as well as select mortgage strategies that we expect will benefit from a buoyant housing market.
Finally, our team believes it’s important to manage downside risk and uses derivatives to employ some protection strategies that may help manage volatility.
And in terms of implementation, every basis point counts. It’s imperative that hedging strategies and turnover in portfolios are managed with precision. We believe investors should purposefully acknowledge the low return scenario they are likely to face over the next several years.
2017 offers few certainties and plenty of potential risks. If the low-return imperative describes your reality—if 2017’s expected market returns are lower than your required rate of return—then we encourage investors to consult financial experts on where else they might find returns, how they might help manage unrewarded risks and how they might help increase portfolio efficiency.
¹Source: Source: MSCI Emerging Markets Index, as of Nov. 25, 2016.
2Source: Russell 1000® Value Index