2021 Outlook: Prepare for post-pandemic portfolios
A consequence of mass containment measures, higher government debt, lower interest rates and expensive equity valuations may be low investment returns. What might investors do to position portfolios for a post-pandemic world?
- The pandemic is accelerating many secular shifts, redrawing prospects for industries and financial markets alike
- Low interest rates and elevated equity valuations point to lower five-year equity and bond returns
- But, equities, especially high-quality companies with strong growth prospects, should outperform bonds while offering a potential hedge against any inflation spike
- Private markets, hedge funds and gold may play a part in constructing multi-asset portfolios capable of prospering in a low-return era
- Similarly, investing sustainably could offer long-term growth at a time when governments and companies are promoting green investments in their recovery plans.
This year’s unprecedented events and the brutal economic shock sparked by the COVID-19 pandemic look set to profoundly affect the outlook for major asset classes next year and many more thereafter.
While many effects of the pandemic are expected to be transitory and fully contained in the medium and long-term due to the exogenous nature of the shock, there are other changes that are likely to be structural. With vaccinations looking likely to be rolled out across much of the world next year, the main question now is around the speed of the economic recovery.
But after the rebound, some areas of the economy will probably be changed for good. For instance, habits ingrained in the last year, like the surge in working from home and online retail sales, may largely stick after the pandemic subsides. In turn, altering prospects for many industries and economic sectors. Longer term, this could hit expected investment returns.
Prepare for a lower return era?
An analysis of prospects for leading economies and asset classes suggests that, at a time of record low interest rates and high equity valuations, total returns for the core asset classes over the next five years may be lower than seen in the recent past.
The expected returns for developed market bonds look unusually poor due to the very low yield levels seen in many countries. Falling yields are heavily weighing on bond returns. For example, the nominal yields on 30-year government bonds in the eurozone and Switzerland are negative. Consequently, expected returns for government and investment grade bonds are negative.
In the US and UK, our analysis suggests that anticipated returns will remain positive, however recent downward shifts of the yield curve have compressed them below 1%. European and US high yielding bonds offer more attractive returns of about 2-4%. Nevertheless, when adjusted for inflation, the returns for lower quality bonds are also hovering a meagre 1% above zero. That said, if inflation were to climb for a sustained period, debt could post even lower realised returns.
Equities may find it tough to make substantial gains given their already elevated valuations on many measures, leaving aside how justifiable such valuations may be in terms of very low interest rates. The elevated cyclically adjusted price-to-earnings ratio hints at multiple contraction over the next five years. This may not occur in 2021 though, given that central banks should remain accommodative.
However, dividends and net buybacks of shares are expected to provide a stable income yield. Overall, developed market equities could offer nominal returns of 5-7% annually over the next five years. Emerging markets will likely provide a risk premium of 1-2% on top of that.
Equities to outperform bonds
While anticipated returns may be historically low, equities offer a decent investment opportunity due to their growth component. Compared to bonds, the asset class can act as a hedge in case of inflation and should still offer returns closer to their historical norm.
With central banks unlikely to tighten monetary conditions next year, and not much apparent scope for expansion, the onus for returns appears to rest on growth. In order to find opportunities for long-term growth, a focus on selecting high-quality companies exposed to secular growth trends, such as healthcare and technology, look attractive.
Additionally, the support for a transition to a low-carbon world seen from governments and companies of late, along with technology developments such as “smart everything”, are likely to offer prospects for long-term growth in a post-pandemic world.
Diversification to the fore
The low levels of volatility seen prior to coronavirus are unlikely to be repeated soon. While uncertainty levels should decrease, compared to last year, they look set to remain relatively high as the effects of the pandemic roll on and geopolitical tensions persist. This suggests that portfolio construction and diversification will matter more.
The diversification benefits of bonds have eroded in the low-rate environment. With income return prospects weak and limited scope for capital appreciation, the effectiveness of a portfolio invested 60% in equities and 40% in bonds is slipping. This seems to point to managing assets in a more tailored fashion to address investing in a time of lower return and higher volatility.
In private markets, investment opportunities appear plentiful in both equity and debt universes. There seems little reason to doubt this will persist, offering the potential to aid portfolio performance. A high-volatility and low-return period could also favour hedge funds, notably in fixed income, despite their relatively poor performance in the last decade.
Depending on the strategy, hedge funds tend to be more or less correlated to equity markets. But even more so than in public markets, the dispersion in the hedge fund investment universe has increased. This means that an active investment approach in this space is of paramount importance for investors looking to produce alpha.
Finally, gold continues to appeal as a solid diversifier in a portfolio. With real rates low, and even negative in some places, the precious metal should continue to offer protection in case of rising volatility without being a drag on performance in quieter periods.
Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.
- Has been prepared by Barclays Private Bank and is provided for information purposes only
- Is not research nor a product of the Barclays Research department. Any views expressed in this communication may differ from those of the Barclays Research department
- All opinions and estimates are given as of the date of this communication and are subject to change. Barclays Private Bank is not obliged to inform recipients of this communication of any change to such opinions or estimates
- Is general in nature and does not take into account any specific investment objectives, financial situation or particular needs of any particular person
- Does not constitute an offer, an invitation or a recommendation to enter into any product or service and does not constitute investment advice, solicitation to buy or sell securities and/or a personal recommendation. Any entry into any product or service requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding documents
- Is confidential and is for the benefit of the recipient. No part of it may be reproduced, distributed or transmitted without the prior written permission of Barclays Private Bank
- Has not been reviewed or approved by any regulatory authority.
Any past or simulated past performance including back-testing, modelling or scenario analysis, or future projections contained in this communication is no indication as to future performance. No representation is made as to the accuracy of the assumptions made in this communication, or completeness of, any modelling, scenario analysis or back-testing. The value of any investment may also fluctuate as a result of market changes.
Barclays is a full service bank. In the normal course of offering products and services, Barclays may act in several capacities and simultaneously, giving rise to potential conflicts of interest which may impact the performance of the products.
Where information in this communication has been obtained from third party sources, we believe those sources to be reliable but we do not guarantee the information’s accuracy and you should note that it may be incomplete or condensed.
Neither Barclays nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation. Law or regulation in certain countries may restrict the manner of distribution of this communication and the availability of the products and services, and persons who come into possession of this publication are required to inform themselves of and observe such restrictions.
You have sole responsibility for the management of your tax and legal affairs including making any applicable filings and payments and complying with any applicable laws and regulations. We have not and will not provide you with tax or legal advice and recommend that you obtain independent tax and legal advice tailored to your individual circumstances.
THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.