Next five years will be a “time of radical transition”, says Robeco
Robeco has predicted that negative real interest rates and high volatility will shape its next five years, in the asset management firm’s tenth annual Expected Returns report (2021-2025).
The Netherlands-based company expects a protracted period of negative real interest rates, meaning their impact on the relationship between economic fundamentals and asset price performance and the consequences for multi-asset allocation will be critical.
Risk taking will be rewarded in the next five years, says Robeco, especially as some traditional safe havens will eventually be deemed risky as well. For most risky asset classes, the expected reward for the volatility risk is substantial, leading to attractive Sharpe ratios. Despite elevated risk premiums, absolute asset returns will remain below their equilibrium values.
“This is a time of radical transition, and volatility will remain elevated,” writes the asset manager.
Robeco says that government bond yields have “only limited room” to increase. Ten-year US Treasury bond yields are capped at 1.5 per cent for the next five years, and, in Germany and Japan, as low as 0.5 per cent. This includes a slight increase in interest rates towards the end of the five-year period as growth starts to accelerate. This means that investors in government bonds will experience negative nominal returns in all main markets. A global government bond portfolio could yield an average euro-based return of -0.75 per cent. Investors in the investment grade segment of the market may gain an above-average credit premium of 1 per cent over the next five years. This results in an outlook of 0.25 per cent.
Robeco expects equity returns to be below their long-term estimates, but risk premiums remain very attractive relative to safer assets such as government bonds. Developed equities are slightly overvalued, mainly because of stretched US equity valuations. Their valuation therefore remains negative relative to the steady state. Nevertheless, its expected return is 4.75 per cent per year. Robeco has upgraded the return forecast for emerging markets. Stronger inflation surprises in developed markets have often coincided with emerging markets catching up on an earnings per-share basis versus developed markets. This results in an expected return of 6.75 per cent.
The preoccupancy of financial markets will shift from central banks to governments. This will bring about higher levels of asset and foreign exchange volatility: politicians offer guidance and policy implementation less smooth than that from their central banking counterparts. The asset management firm adds that a key question to consider in scenario thinking is whether policymakers will succeed in getting real rates low enough for a substantial period of time to facilitate a self-sustaining economic recovery. Robeco believes they will. But their success will depend, more than ever in post-war history, on close collaboration between the monetary and fiscal authorities.
Peter van der Welle, strategist Multi Asset at Robeco: “In last year’s publication we penciled in a recession. Obviously, we did not envisage that the Covid-19 crisis would be the instigator of this. We expect asset returns to remain below their long-term historical averages over a five-year horizon, mainly caused by the low interest rates. The macroeconomic volatility will only start to fade in 2021, but the effective cooperation between central banks and governments will lead to a successful recovery. The accompanying increase in inflation rates combined with low bond yields leads to our ‘Brave real world’, looking to overcome the challenges of achieving a sustainable, greener future.”
Laurens Swinkels, researcher at Robeco: “In line with tradition, in the tenth edition of this report we look beyond short and mid-term events and provide investors input for portfolio construction, as well as a deeper understanding of the markets in which they invest. A notable shift in this year’s report is our upward revision of expected returns on global equity markets, because we have faith in the coordinated response of governments and central banks to resolve the economic downturn in the coming five years.”
In addition to the five-year outlook, the report also covers five special topics, related to the theme: ‘Brave real world’:
- There is more to factor investing than Fama-French’s five factors
- Interest rates – don’t be so negative
- Carbon pricing: asset allocation and climate goals
- Money for nothing, inflation not guaranteed
- Trends investing: is skewness in equity returns a blessing in disguise?