Expect to see a global economic growth of around two per cent
Due to demographics, the deglobalisation trend, costs of climate change and higher national debt, economic growth and corporate earnings will increase more slowly in the coming decade than the last decade.
As our base assumption, we expect to see global real economic growth of around two per cent. If European acceptance of the market economy continues to decline and there is an increase in regulatory density and interference with property rights, growth on the European continent will drop even more significantly below the global average than currently expected.
The period of extremely low inflation rates will likely come to an end during this decade. As our base assumption, we expect an average inflation rate of two per cent for the coming decade. No one can seriously predict how much a potential loss of confidence in the monetary system might increase inflation. There is a relatively high probability that the coming decade will go down in history as a decade of financial repression. Zero and negative interest rates have penetrated so far into economic life, financial planning and the human psyche that they are increasingly perceived as normal. Businesses, private households, real-estate investors and finance ministers are now almost unable to imagine a life like the world of yesterday, when interest was paid.
The longer the low interest-rate environment continues, the more people will become accustomed to it and the lower the probability of an interest-rate turnaround. The possibility of national debt decreasing in the normal manner to a sustainable level again – e.g. a maximum of 60 per cent of GDP, as previously specified in the Maastricht agreements – is an illusion for many highly-indebted countries. They still have adequate breathing room, however, as long as interest rates remain significantly below the rate of inflation. It is therefore unlikely that the new ECB President Christine Lagarde will be able to introduce monetary policy normalisation during her term of office, which runs to the end of 2027, particularly given that, unlike her US colleague Jerome Powell, she also has to preserve the euro.
In an environment of ongoing negative real interest rates, real assets will likely achieve a far better long-term performance than nominal assets. Although this was also true for the decade just ended, more attention is now being given to capital protection. A euro in the savings account of a small investor will likely only have a purchasing power of EUR 0.80 by the end of the decade, and this amount will be even lower for large investments due to negative interest rates.
Although real estate offers better protection against inflation, it offers no protection against government interventions during a period of financial repression. Higher property taxes, property transfer taxes and rent ceilings are effective methods for siphoning off inflation gains. Partial expropriation has already begun for property owners in Berlin.
Equities, on the other hand, offer higher current returns than bonds or savings accounts and better inflation protection. At least this is the case for shares of companies that can increase their sales and earnings at around the same rate as inflation, which is especially true for global companies with strong competitive positions and adequate power to set prices. Another advantage of equities is that it is more difficult and, in particular, more counterproductive for governments to access company assets. A country that hollowed out the assets of its companies would quickly fall behind internationally and bring about its own ruin in the long run.
The annual nominal and real expected returns shown in Table 2 for the different asset classes represent our working hypothesis based on the assumptions above and therefore form the basis for our long-term investment strategy. A 10-year German Bund is guaranteed to generate nominal and real losses in value by the end of the Twenties. Good-quality corporate bonds with the same maturity are not expected to provide much more. Real losses in value are also practically guaranteed for bank accounts and savings accounts. In the case of gold, we assume its price increases at the rate of inflation and therefore real capital is preserved. The price of gold could also increase significantly more if there were a loss of confidence in the monetary system, something we will hopefully be spared.
We estimate the annual expected return for equities to be 6.6 per cent and 4.5 per cent after inflation. Equities are therefore the only asset class expected to achieve an increase in real value over a period of 10 years. We also assume that the valuation level for equities will remain the same as today, even though the ongoing low level of interest rates would clearly justify an increase in this multiplier.
Even if the valuation level were to decrease and share prices were to rise marginally, in retrospect investors would find in 2029 that the total return earned by equities during the Twenties would be significantly higher than all other liquid asset classes and once again probably higher than real estate – if only because of the 2.5 per cent annual return from dividends.
The asset class returns that are shown are passive returns, that is, the result of a pure buy-and-hold strategy. In the case of bonds, they are held to maturity. We have not included potential additional returns due to good security selection (stock and bond picking), even though this could generate significant additional returns.
Asset management: an industry undergoing radical change
The extremely low level of bond yields presents a major challenge for the entire asset management industry. Portfolio managers will have to actively use the complete repertoire of the bond universe to preserve real capital with bonds in the coming decade. It will be impossible using bond funds that only cover a narrowly defined investment universe, such as high-quality or short-maturity government bonds. And, if high-return segments such as US dollar or emerging market bonds are not used, not much more can be expected from bond exchange-traded funds (ETFs) than to lock in a zero return.
The situation is different for equities. If our expected returns for the coming decade are realised or even exceeded, attractively priced ETFs would be an alternative to standard equity funds. In the USA, they are already beating actively-managed funds with respect to growth. This is not surprising, since the majority of active funds have failed to outperform the S&P 500 – the natural benchmark for practically all US investors – for years. ETFs also receive preferential tax treatment, which is lacking in Europe. Institutional investors that manage their own asset allocations are increasingly shifting investments into ETFs. At USD 2.6 trillion, equity ETFs already represent 24 per cent of the US equity fund market. Their volume has increased more than five times and their market share has more than doubled in the last 10 years.
Exchange-traded index funds are also on the march in Europe, although the volume and market share of equity ETFs are considerably smaller, at USD 600 billion and 11 per cent, respectively. Since Europe does not have a dominant benchmark index like the S&P 500, ETFs will likely not achieve the same market penetration there as in the USA in the future. The cut-throat competition among asset managers will nevertheless also continue to intensify in Europe. Index funds are a pure economies-of-scale business. By far the most important differentiating factor is the fees, which can be reduced continuously as investment volume rises.
That is why the market is now dominated by two US giants, BlackRock and Vanguard. Niche segments and regional markets are the main areas remaining for European providers. Active managers, who demand relatively high fees, must show they provide added value to justify those fees. This is much more difficult for equities than it is for bonds, where the market is less efficient due to the large number of different issues. Active managers, particularly in the USA, are therefore already suffering a slow death.
Given this background, it is easy to see that the attractiveness that sustainability has for the fund industry is also based on the potential for sales of new, high-margin investment products. Although a coat of green paint is in the spirit of the times, it is unable to deliver the value proposition to the client or do anything for the environment, society or the quality of corporate governance in the long run. Sustainable and successful long-term investment cannot be externally prescribed.
Not by a taxonomy or a marketing department. It has to be lived. This requires a comprehensive understanding of sustainability that starts with the integrity of the company’s corporate governance and assesses its activities in relation to the two other ESG factors, the environment and social issues. This in turn requires intensive involvement with the companies, which is why we feel it is counterproductive to isolate and outsource sustainability to a separate ESG department. Due to a lack of detailed knowledge of the companies, such departments could only use general rules or ESG ratings from external agencies. Our analysts use ESG analyses as additional input for identifying the potential weaknesses and risks of a company, but never as the sole basis for a decision, as they cannot appropriately take into account the special features of the individual companies.
The bigger the investment universe and discretionary freedom of an active manager, the greater the probability of generating added value for clients. This is particularly true for investors that cannot or do not want to build their own portfolios from individual index components like a do-it-yourself handyman, and are looking instead for a full-service solution for their investments. They expect an attractive risk-return ratio and want to delegate detailed decision-making to a trusted asset manager. These goals can best be achieved with multi-asset concepts that can ideally make flexible use of the full range of investments. Rigid mixes, on the other hand, such as 50:50 equities/bonds, generate almost no added value and can be easily replicated using index funds. Multi-asset funds, however, are not all alike. The only common characteristic is that they invest in more than one asset class. They differ greatly in terms of the number of asset classes, risk profile (typically from defensive to growthoriented), the flexibility of fund management and implementation of the strategy using individual securities or funds. Multi-asset funds are not an all-in-one solution that can match the performance of equities with no volatility.
They are, however, the best way to move investors that have traditionally given equities a wide berth to a more reasonable investment strategy. We aim to continue delivering our value proposition to clients in the upcoming decade and providing above-average long-term investment performance based on a prudent investment strategy. Our focus is on intelligent diversification and individual security selection based strictly on risk-return profiles. Our goal is to provide better performance in the Twenties than the expected returns shown in the table. There will be good years and years that are not so good. We will try to avoid the truly bad ones.