Complex Made Simple

Assisting investors to understand the long-term return potential for various asset classes

Global Investment House (Global) announced the introduction of a new strategy report, The Global View: Strategic Investment Outlook, a 60 page report which presents the company’s view on worldwide economic and market developments. After analyzing the recovery of key economies and asset classes globally, the report presents the firm’s outlook for further economic growth, asset class return potential and key risks in the markets.

The aim of the report is to assist investors in understanding the long-term (5-year) return potential for investments in various asset classes including equity, fixed income and other asset classes around the world. This is even more important now as most asset classes have risen strongly since the markets reached their lows in 2009, with many asset classes delivering double-digit average annual returns since then. After 5 years of strong returns with some asset classes at record highs, investors will need to reset their expectations as we believe we have entered a period of slower market performance. In this environment, picking the right asset classes will be crucial for maintaining strong longer-term returns.

Global is most positive on two areas within equities worldwide. European equities look appealing, given the potential for strong growth in margins and earnings as the region continues its recovery after the Eurozone crisis. GCC equities should also perform well given the outlook for robust economic growth and continued government spending, which should benefit companies in the region. In both cases, Global believes longer-term total returns of up to 10% annually on average are possible.

The firm’s view on fixed income is overall conservative as yields look to have bottomed and will likely rise going forward. The impact of the US Federal Reserve Tapering, or reduction in asset purchases, as well as potential interest rate increases in 2015 mean fixed income products will see yields continue to rise and thus prices and returns lower. Within fixed income, the high yield space seems to be one of the few which can still offer meaningful return potential as spreads could decline further, thus offsetting any increases in underlying rates.

The report also presents Global’s asset allocation and portfolio construction methodology. For investors attempting to navigate the changing investment landscape, we believe maintaining a well-diversified portfolio of assets will be important in managing the inherent uncertainty and risks while maximizing returns. Our portfolio construction process incorporates the individual circumstances of each client with the statistical asset allocation methodology of the Black-Litterman model. We include examples of various longer-term Strategic Asset Allocation (SAA) portfolios which incorporate 11 global asset classes across five different risk profiles. We also include additional examples of portfolios focusing on the main international equity and fixed income asset classes, which may be more familiar to our regional client base. For our shorter-term views, we detail our Tactical Asset Allocation (TAA) weightings on the various asset classes. Our current TAA stance is to overweight Equities through overweights in European and GCC equities, while we would underweight fixed income through underweights in all of the fixed income asset classes except for high yield.

The report highlights five themes which investors should be aware of as we move through the coming year. The themes are: 1) The impact of the US Federal Reserve Tapering, 2) Changes in market volatility and how it can impact returns, 3) Changing asset class correlations means picking the right assets will be crucial, 4) Worldwide economic growth is picking up, and 5) There are still many geo-political risks which investors should keep in mind.

The report then details the current state of the global economy by analyzing the recovery in key regions worldwide. The focus is on the main countries and regional areas including the USA, Europe, China, Japan, emerging markets, and the GCC (Gulf Cooperation Council) countries.

Analysis covers wide ranging issues in each of the regions, from the US unemployment recovery to the state of the banking sector in Europe. In China, analysis includes the impact of the rise of investment trusts and the shadow banking sector on economic expansion. And in Japan, the analysis focuses on the potential for the “3 arrows” strategy of Abenomics to pull the country out of its 20 year period of stagnation. For emerging markets, the outlook for different economies based on changing investor fund flows and relative current account and budget balance strengths is analyzed. Special attention is also given to the GCC markets as we believe these economies stand out as amongst the strongest globally on a number of factors.

The next section of the report details the firm’s outlook for the main international equity and fixed income asset classes. We highlight that the returns achieved in the various investment markets over the past five years of recovery after the financial crisis are far different from what we expect the next five years to look like. Global equities have returned over 20% annualized over the five years since the March 2009 bottom in the markets was reached. Looking forward, we expect total returns to be much lower given higher current valuations. However, we believe equity markets can still deliver meaningful total returns in the 5-10% range annually, with Europe and the GCC markets the areas we favor most.

The outlook for fixed income is less positive as we believe the 30 year bull market in US treasuries has ended after yields reached record lows in 2012. The rising yield outlook means returns on most fixed income products in the coming years will be very low and even negative in some instances if yields move rapidly higher. We note that the benchmark 10-year US Treasury reached a historic low yield of 1.4% in 2012 but has since risen to 2.6% currently and we expect this to continue rising to the 4-5% range over the next 5 years. With the rising yields, total returns on government debt as well as many other fixed income asset classes are thus expected to be very low during this time.