Some thoughts on asset class returns over the next five years

Being a ‘diversified investor’ means being across all asset classes – their individual foibles, their inter-relationships, their likely future returns, their volatility. Only by doing that can you mix and match them in a way that maximises investor returns for a given risk profile.

This is in contrast to BT Investment Management’s Australian equities team, for example, whose skill is making assessments on individual stocks within the Australian share market.

Financial markets as a whole seem to be at a point where there are many cross-currents. Despite this, as we said in one of our previous posts, our view is that the bell for the top of the markets has not yet been rung, i.e., on many theoretical/conceptual valuation methods it would seem that Australian equities, as an example, are not unfairly valued.

We can’t say by precisely how much or how little, however, because as we pointed out in that article, all you need is a small change in the assumptions like rates or risk premia (particularly with the risk free rate so low) and you can get significant changes in ‘fair value’.

Over the longer term there may be more productive questions to be asked rather than obsessing over the accuracy of theoretical assumptions – two of the most important being: ‘What will I get from holding equities?’ and ‘How does this compare with what I will get from other investments?’. Let’s take a look at what we think…

Expected 5 year return

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Expected 5 year volatility

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Our current five-year forecast for Australian equities is approximately 10% p.a., with volatility (risk) of 13% p.a. This is the ‘fair value’ return implied by the current market price given earnings expectations. In a total return sense, that looks pretty good when you line it up against a range of other assets classes, particularly defensive assets like fixed income and cash which we estimate at 3-4%. Of course, one should also consider volatility when building multi-asset portfolios.

Asset classes cannot be looked at in isolation because money needs to be put somewhere and decisions will be made between them. In this environment, Australian equities may not be screaming ‘buy me!’, but, pending a major financial or geopolitical dislocation, neither are they whispering to sell.

 

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