What sort of returns should investors expect?

08 December 2017 | Markets and Economy


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Sophie Carlin
Vanguard Europe – Moderator

Peter Westaway
Vanguard Europe – Chief Economist and Head of Investment Strategy

Alexis Gray
Vanguard Europe – Senior Economist

Sophie Carlin: What sorts of returns should investors expect in the long term? I think that is one of the questions on many people’s minds.

I am Sophie Carlin and I have here with me today Peter Westaway, chief economist, and head of investment strategy at Vanguard Europe, and Alexis Gray, senior economist.

So Peter, equity returns have been looking strong recently with the FTSE All World up 20% this year. So can we expect more of the same and what does the future hold?

Peter Westaway: Unfortunately, I don’t think we can expect more of the same, because we have to remember that asset returns have been buoyed up by a couple of factors recently. First of all, they have been strong because there has been an inevitable rebound from the financial crisis in 2009, and second, policymakers have deliberately been putting stimulus into the economy to try and boost asset markets to try and encourage people to spend more, so both of those factors mean we can't really expect them to continue going forward. 

Sophie Carlin: And Alexis, what does this mean for investors?

Alexis Gray: Well, if we look at the chart, which is our projections for real inflation-adjusted returns over the next decade, what we can see here is we have got both UK equities, UK bonds, global equities and global bonds.

Sophie Carlin: And could you explain what some of the different lines on these graphs mean?

Alexis Gray: So what we’re showing for each given category is where our estimate lies, starting with the fifth percentile, so our lowest possible outcome, all the way up to the top, which is our 95th percentile, and then our median is where those two colours meet in the middle. The key takeaway here is that the projections for equities have a much wider band, which illustrates the uncertainty we have in projecting equity market returns relative to fixed income.

Sophie Carlin: So Peter, let's take a practical example to put this into context. What could an investor in, say, investment-grade fixed income expect to receive?

Peter Westaway: I think that is almost the most interesting element of this chart, because if we look at that median expected return, what it shows is that in real inflation-adjusted terms fixed income investors can expect zero, or you adjust that for inflation, they can expect 2% returns over the future. And if you compare that to the average returns that investors have been receiving, say, since 1980, they might have got around 5%. You can see that 5% number if you look at the black diamond on the chart, so it’s quite an extraordinary change.

Sophie Carlin: And Alexis, the same question but for equities.

Alexis Gray: So for equities, it is a slightly different story. I think our medium projection is around 2.5%, but once again, below historical norms, which were around 7%, so we’re expecting lower returns than in the past.

Sophie Carlin: So Peter, we have heard 0% returns for fixed income, 2-3% for equities. Why are expected returns so low?

Peter Westaway: Well, I would say there were two main reasons for this. First of all, if we go right into the future, we think that the long-run returns that we might expect on assets are going to be lower than they have been in the past, and that is really because real interest rates are driven by global growth prospects in the world economy, and we think global growth is just going to settle down with a lower rate than it has done in the past. But then over the more immediate future, I think it is the case that asset markets are slightly artificially inflated by some of these policy measures, and as a result of that, we can expect some correction from that as well, so that is all so going to bear down on returns.

Sophie Carlin: Alexis, how can we as investors respond to this?

Alexis Gray: Well, I think the typical strategy that investors have used is to try to move their money into more risky assets, like equities or property, but as the name suggests, that is a risky strategy, which has potential downsides. I think the reality of the situation is, though, that we need to adjust our expectations for the future, and perhaps try to save more money, either by working for longer or perhaps not taking a holiday, just being a little bit more careful with our money, so we have more income in retirement.

Sophie Carlin: So the sky isn't falling in, but our market outlook as dimmed somewhat. Investors should expect more subdued returns in equity and fixed income over the coming years. There is no magic fix, but it does underscore the need for investors to be disciplined, globally diversified, and armed with effective low-cost strategies. Peter, Alexis, thank you very much.

Please remember that historical returns are not an indicator of future returns. Investments and the income you get from them can rise as well as fall, and you may not get back the original amount you invested.

Find out more about Vanguard's economic and market outlook for 2018.

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