(Part one of two) Investors are increasingly of a view that the future will be tough and they will face a long period of unprecedented challenges. This evolving environment will likely have profound consequences not only for how investors make investment decisions, but also for the future of the asset management industry. I believe this is the time to rethink our business as an asset manager and build new partnerships with clients.
From an investment point of view, we foresee long-term expected returns for all asset classes (on a 10-year horizon) continuing the downward trend that characterized the last decade.
Asset Class Performance by Decade, 1975 – 2015
Source: Pioneer Investments, Bloomberg. Analysis on monthly data from 31 December 1975 to 31 December 2015. Equities = S&P500 Index, Government Bonds = BofA Merrill Lynch US Treasury & Agency, Corporate Bond = BofA Merrill Lynch US Corporate Master. All indexes are in USD, total return. Indices are unmanaged and their returns assume reinvestment of dividends, and unlike Fund returns, do not reflect any fees or expenses. You cannot invest directly in an index. Data represents past performance, which is no guarantee of future results.
As a consequence of unconventional Central Bank monetary policies, core government bond markets, with yields close to zero or even negative, can no longer fulfill their traditional role as income producers and “risk-free” diversifiers in investor portfolios. After years of liquidity-driven bull markets in “risk assets,” the obvious directional opportunities have also diminished. At the same time, we believe the risk of extreme events is growing driven in part by markets having lost their blind faith in the power of Central Banks. The transition of many major economies towards a sustainable growth path has been decidedly bumpy in the aftermath of the Great Financial Crisis, as we have seen with China and other emerging markets.
In developed countries, low investment, the debt overhang and subsequent low productivity are limiting growth potential and heightening the risk of macroeconomic volatility. High unemployment, especially among young people, is accentuating intergenerational disparities extending the inequality between beneficiaries of asset price inflation and those relying on stagnant labor income.
The geopolitical framework is fragile: Europe is dealing with the ongoing refugee crisis, the terrorism threat and powerful forces which jeopardize the whole EU construct, while the rise of populism around the world further threatens the status quo. The outcome of the UK referendum is a tangible manifestation of these themes.
Two elements about this environment are worth considering for investors:
- First, in our view, this is not going to be a temporary phenomenon, but a structural one. The long-term trends that have underpinned bull markets over the last twenty years simply don’t exist anymore: the emergence of China (and other emerging countries) has upended the economic pecking order, while the backlash against globalization in many markets has sapped the momentum behind progressive improvements in productivity and moderate price increases.
- Second, the deleveraging phase of the credit cycle will take many years to unfold, following the unprecedented expansion of indebtedness on the part of both governments and corporates, and may do so in jarringly uneven fashion.
Therefore, this scenario will require a rethinking of how to build resilient portfolios to navigate this new market paradigm.
If we look at how the financial industry has evolved during the favorable climate of the last few decades we note that:
- It has enabled the steady increase in households’ exposure towards financial assets and especially to asset management products. The global asset management industry reached $71.4 trillion of total assets in 2015, more than doubling its value since 2002.
Asset Management Industry Global AUM ($ Trillion)
Source: BCG Global Asset Management Market Sizing Database 2016.
2. Within the overall growth of asset management, passive products have grown disproportionately, due to their lower costs and a skepticism about whether active managers can beat benchmark market indices.
Actually, going back thirty years, the use of a market index “benchmark” as a comparator or target for investor portfolios was one of the main “innovations” of the financial industry. Its broad adoption initially resulted from the fact that it was a “simple” indicator to measure active management and subsequently the same indices were easy starting points for developing low-cost “tracker” investments.
We believe that the new environment for investors will entail a radical rethinking of the benchmark concept as well as what we view as an “artificial” separation between active and passive management. Increasingly, asset management will mean delivering investment solutions measurable against a concrete economic goal: for example, a certain set of minimum nominal returns or an excess return over inflation. Less and less will asset management activities be measured simply by their outperformance versus a traditional market index.