The economic effects of the Coronavirus have led to extremely low interest rates (offshore developed countries nil and South Africa 3.5%), driven by central banks slashing rates to stimulate economic growth. In addition, inflation has declined to 16-year lows (offshore developed countries below 1% and South Africa 2.1%), driven mainly by a decline in demand as economies have stalled.
Forecasts for the next 1 to 3 years are for interest rates and inflation to remain at low levels. Taking this into account it is likely that investment returns over the next few years should be lower than normal. Especially in the case of conservative and income-generating funds.
Investor return expectations are declining
In a recent Coronation investor survey, overall return expectations had declined. 61% expected a return of 10% or more over time, down from 82% in 2017. Interestingly, more than 25% did not know, which is the highest level of uncertainty since the first survey 4 years ago.
The average long-term growth expectation is 10.9% per year, down from 12% in 2017. Coronation’s forecast for its balanced fund is a 9% to 12% annual return for the next decade.
The real area of concern is the Income Fund high return expectation of 9.3% per annum, which is well ahead of the Coronation Strategic Income Fund’s historical 10-year average return of 8.4%. However, looking forward with low interest rates likely for the next 2 to 3 years, Coronation expects an Income Fund return of 5% to 6% to be a good outcome for the next 3 years.
An alternative is a fixed deposit investment, but the risk is no hedge against inflation
A three and five-year RSA Retail bond currently yields a 6% and 8% annual return, respectively. Other reputable institutions are offering five-year fixed deposit returns up to 8% per annum. The negative with fixed deposits is that interest is fully taxable (above annual interest exemptions) and doesn’t provide any protection against an increase in inflation. An increase in inflation in a few years’ time is a serious risk, given SA’s ballooning government debt and its likely reliance on foreign loans into the future.
Beware, offshore equity markets are expensive
The US S&P 500 (comprising 60% of the World MSCI Index) average returns over the last 10 years is 13.6%, more than double its long-term average. This has been driven by low interest rates, declining tax rates and widening profit margins. These unsustainable earnings boosters, plus the full economic fallout from the Coronavirus that remains to be felt, do not bode well with a high valuation (28x P/E), near historical highs and well above its long-term 14x average.
The best returns are still achieved over the long-term
Although short to medium term returns do not appear exciting, the best investment returns are achieved over the long-term. Over the last 50 years the JSE has returned an average real (above inflation) equity return of 7% per annum. Over the last 20 years the average multi-asset balanced unit trust has produced an average 5.5% real return. This is significant, but it is a long-term investment, which does come with ups and downs that are more difficult to tolerate as we near retirement.
Most important is to achieve an after-tax return above inflation over the long term
Over the last 20 years SA inflation has averaged 5.5%. Assuming a 30% tax rate, one has had to achieve an average nominal annual return of 7.9%. Over the last five years the average equity and balanced fund nominal returns have been 1% and 4% respectively, below inflation.
Such returns have driven investors to seek out fixed deposits or life annuities, which pose a major risk of not being protected from higher inflation in a few years’ time.
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