A decade of lower returns

INVESTORS should expect substantially lower returns from all major markets over the coming decade, fund manager Perpetual has warned.

Perpetual’s projection echoes many other investment experts, led by famous US investor Warren Buffet, who don’t expect the high returns of the 1980s and 1990s to be repeated in the current decade.

Brigette Leckie, Perpetual’s Head of Investment Markets Research, said low market returns would make active funds management even more important.

Returns from international equities are expected to fall from 22.0 per cent a year in the 1990s to about 10 per cent a year this decade.

Returns from Australian shares are expected to fall from 14.8 per cent to about 9 per cent.

Investors who diversify, by putting their money in a balanced fund (ie a mix of shares, property, fixed interest and cash) will not be spared from the lower returns (see table).

Ms Leckie said returns in previous decades were boosted by factors that were no longer present.

In the 1970s and 1980s, it was high inflation that boosted nominal returns (but not real returns).

In the 1990s, returns were boosted by a big increase in the share market’s price-earnings (PE) ratio.

The PE ratio measures the relationship between the price of a company and its annual earnings, or profits.

In the 1980s, Australian companies collectively were valued at about 12 times their annual earnings. In the 1990s, the ratio increased to about 22 times.

Ms Leckie said this was driven by a big drop in inflation and interest rates, which, in turn, reduced the discount factor, or risk premium, applied to shares.

In the current decade, Perpetual is projecting continued low inflation and little change in the market’s PE ratio.

Therefore, sharemarket returns will be driven by growth in company earnings, which Perpetual links to projected economic growth of 5.8 per cent per annum (including inflation of 2.5-3.0 per cent).

Add dividends of 3.0 per cent per annum and you get projected returns from Australian shares of between 8.5 per cent and 9.0 per cent a year.

In this market environment, the ‘extra’ returns delivered by active managers – who seek to outperform the market as a whole – take on greater significance.

Over the past five years, the top 25 per cent of fund managers have added five percentage points to market returns.

Ms Leckie said a conservative assumption was that a good active manager would add three percentage points to market returns.

These extra returns are a handy bonus when the market as a whole is delivering high returns.

But they become critical when the market return falls to just 6.0 per cent (before inflation), as Perpetual has projected.


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