Looking Ahead - Improved expected returns

Friday 25 November, 2022

Investors that are willing to look beyond short-term uncertainties should benefit from an increase in the long-term expected returns for the major asset classes. 

Background

The last decade has largely seen a world of respectable growth, low inflation and supportive central bank policies across most economies. However, as evidenced by the high levels of market volatility seen during 2022, investors have become concerned about a new potential regime emerging, in which inflation uncertainty, global deleveraging, less accommodating central banks and increased geopolitical risk all feature. 

Whilst some short-term uncertainty will remain, the silver lining for long-term investors is that market participants are now demanding prospective higher returns for investing in assets over the long-term (i.e. investors are demanding a higher risk premium). 

As a result, the forward-looking expected returns for asset classes that feature within Hymans Robertson Investment Services (HRIS) model portfolios are notably higher than they were at the beginning of the year. 

Forward looking returns 

The table below shows a comparison of the 10-year returns that Hymans Robertson’s long-term institutional ‘Economic Scenario Service’ model was projecting at the end of 2021, compared to the position at the end of September 2022. 

Table 1: 10-year expected returns per annum (comparison: December 21 vs September 22) 

10-year expected returns (% p.a.)	31 December 2021	30 September 2022
Cash	1.8%	4.2%
Investment grade bonds	1.6%	5.2%
High yield bonds	3.4%	6.9%
UK equity	5.7%	8.2%
Developed equity (ex UK)	5.6%	8.0%

 

We can see from the above table that there has been a material increase in the forward-looking returns that investors can now expect to achieve.

These projected returns are ‘per annum’ and it is important to note how the power of compounding is in favour of those investors remaining invested for the long-term. As an example, an investor with a pot of £100k (assuming no further contributions) would now expect a 60/40 equity/bond portfolio (1) to be worth £196k in 10 years’ time, compared to £150k based on the projection at the end of 2021.

Final thoughts

It has been a challenging year so far for investors with both equities and bonds delivering negative returns.

Within HRIS model portfolios we have managed to partially protect our clients from this, through a combination of:

• Having built robust investment portfolios, which included each portfolio being scenario tested against 5,000 different potential economic scenarios.
• Being well diversified – such that portfolios are not overly exposed to any one geography, sector, style of investment or asset class.
• Having carried out detailed due diligence and research of the underlying funds and managers.
• Carrying out detailed monitoring of portfolios to confirm they remain suitable for clients and aligned to portfolios’ target markets.
• Providing ongoing analysis and market commentary to advisers, to support conversations taking place with their clients

In Summary

Looking forward, we continue to believe investors will be rewarded over the long-term for investing in long-term asset classes such as those outlined in this note. We also believe the current levels of projected returns look attractive.

Considerable market uncertainty could persist, which could result in short-term volatility, but to manage this risk we continue to apply the points raised above, most notably building strategic portfolios that are diversified by asset class, sector, investment style and underlying funds.

Hymans Robertson Investment Services (HRIS)

(1) 60% equities assumed to be 50% developed equities (ex UK) and 10% UK equities. 40% bonds assumed to be 10% gilts, 20% investment grade credit, 10% high yield credit.

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