The low or negative long-term real interest rates that
prevail across the developed world currently mean two
things.
First, they mean that real returns from long dated
developed market government bonds will almost
certainly be low or negative. For them to produce decent
real returns, inflation would have to be substantially
negative, and for many years. This is unlikely given
that central banks can always prevent such through
use of their printing presses.
Second, they reflect the fact that economic growth
going forward is likely to be lower than in the past,
perhaps considerably so (lower economic growth
means a lower return on capital and thus a lower cost
of capital i.e. lower interest rates). If economic growth
is going to be lower, real returns from equities will also
very likely be lower.
So, it is not out of the question that the expected real
return on a 50/50 bond/equity balanced fund will be
much lower going forward than it was in the past.
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How To Improve Your Investment Returns
First, do not hold any developed market government
bonds. This will make you feel very uncomfortable,
as government bonds are generally considered the
bedrock of any in-retirement savings pot. The way to
overcome this discomfort is to change the way you
think about risk. Government bonds – at least those in
the developed world - are considered low risk because
their returns are generally very stable. But if real yields
are low or negative, your real capital will likely be
permanently eroded over time as mentioned above.
Our suggestion would be to think of risk in terms of the
scope to lose real capital rather than in terms of shortterm price volatility. You will then be able to think of
developed market government bonds as being high
risk, not low risk.
Second, with respect to equities, go active. There has
been a huge move into passive funds in recent years
but all this does is provide exposure to market returns
in general, which as mentioned previously will likely
be lower. Going active does not mean lots of activity.
Quite the contrary in fact. Going active means targeting
subsets of equity markets such as smaller companies or
higher yielding stocks. These types have demonstrated
in the past a propensity to perform well.
Be Selective
It can also mean being selective - with some fairly
rudimentary analysis one can construct a portfolio
that consists of a small number of companies that can
be held for the long term. There is no right number
– holding too many companies means little scope to
produce excess returns, too few means too much risk.
It is about balance.
Again, you may not be comfortable with this approach.
Our suggestion would be as it was for bonds – change
your definition of risk. Yes, smaller companies
exhibit higher short term price volatility than bigger
companies, but over the longer term they have in many
countries performed better. As for holding a smaller
number of companies in your portfolio, understand
that holding a large number of companies is only going
to generate mediocre returns – that is effectively what
passive funds do and thus what you should be seeking
to avoid.
Be Comfortable
One can argue that in retirement one does not have
the luxury of exposing oneself to high short term
volatility. This is wrong, in our view. In the event that