New Tactics Needed for a Low-Rate World

Investors must rethink “safe havens” in their portfolio now that bonds simply can’t offer the same combination of portfolio protection and positive income.

J.P. Morgan Asset Management has published its 2020 Long-Term Capital Markets Assumptions report, with a focus this year on exploring the complexities of late-cycle investing in an environment of ultra-low bond yields.

During a media roundtable held in New York to unveil the new report, John Bilton, head of global multi-asset strategy, highlighted the impact of trade uncertainty between the world’s economic superpowers and a recent reversal in the trajectory of global monetary policy.

“In an environment of very low bond yields, investors must reassess how to design the optimal portfolio, as the tradeoff is no longer between foregone risky asset returns and reduced portfolio risks—but is instead between a zero or even negative return in exchange for that risk reduction,” Bilton said.

David Kelly, chief global strategist for J.P. Morgan Asset Management, noted that global growth expectations for the 10 to 15 year time horizon remain relatively modest. He cited such headwinds to growth as aging populations in developed economies, and noted that one important tailwind for stronger-than-expected growth could be a technology-driven boost to productivity. Kelly noted that over the last year, the economic cycle matured even further, becoming the longest U.S. expansion on record and creating a sense of the “new abnormal.”

“Portfolio flexibility remains key for investors looking to manage cycle uncertainty,” Kelly said, “with those seeking higher returns continuing to be drawn to private markets and other alternatives as both a diversifier and a source of excess returns.”

Pulkit Sharma, head of investment strategy and solutions at J.P. Morgan Alternatives Solutions Group, emphasized the growing importance of alternative investments, and particularly private equity, for institutional investors.

At a high level, the trio said they expect global growth to average about 2.3% over the next 10 to 15 years, down 20 basis points from last year’s projection. The developed market forecast remains unchanged at 1.5%, while emerging market forecasts have been trimmed 35 basis points to 3.9%. Population aging is broadly to blame for the lower forecasts for global growth, the J.P. Morgan experts explained.

Projections for global inflation also remain low, and global monetary policy is expected to remain “extremely accommodative” throughout this cycle and well into the next one—leading to a significant delay in rate normalization. That fact, in combination with much lower starting yields and a modest cut to the firm’s equilibrium yield estimates, adds up to a sharp fall in projected fixed income returns—in some cases taking them negative over the forecast horizon.

Suggesting ways investors can address this muddle-through outlook, the J.P. Morgan team pointed to the alternative investments and private equity space as a developing opportunity set. They noted the 10 to 15 year aggregate private equity return forecast has been raised 55 basis points to 8.80%.

“Private equity continues to be attractive to those investors looking for return uplift, as well as those seeking more specific exposure to technology themes,” Sharma said. “This year we forecast that core U.S. real estate returns, levered and net of fees, will average 5.80% over the next 10 to 15 years. Casting the net more widely, forecast returns from global real assets and infrastructure have held up remarkably well, and given the resilience of their cash flows, they may even serve as a proxy for duration in portfolios with limited short-run liquidity demands.”

The J.P. Morgan leaders said they hope and expect that, over time, investors in defined contribution (DC) plans will gain greater access to alternatives, real assets and private equity placements. The 2020 report notes that aversion to real estate in particular seems to stem from the central role overvalued property markets played in triggering the global financial crisis back in 2008. But, the report argues, a longer-run analysis of through-cycle real estate returns suggests that the global financial crisis was an anomaly and that real estate returns generally remain robust throughout the cycle.

“This year, we forecast that core U.S. real estate returns will average 5.8% over the next 10 to 15 years, withe some way ahead of the returns available from a balanced 60/40 stock/bond portfolio,” Sharma noted.

Overall, the 2020 long-term capital market assumptions forecast modest growth and contained inflation, and they recognize the challenges to portfolio construction that zero and negative bond yields present. The environment is complicating the late-cycle playbook for those investors with an eye on tactical asset allocation. There are bright spots, but even then, investors need to appreciate the tradeoffs implicitly required to capture enhanced returns. Credit offers sizable return pickup over sovereign bonds, but with large drawdown risk when the economy turns; real estate returns are attractive, as are those in private equity, but illiquidity is a consideration; and emerging markets returns are forecast well above developed market returns in most assets, but in the short run, the persistence of trade uncertainty will remain a headwind.