Illustration: Colin Daniel

Markets are set to remain uncertain over the next decade, and while you, as an investor, have little control over the resulting volatility, you can control your reactions to the investment environment, Henry van Deventer says.

The effects of the global financial crisis of 2008 are still raging all around us, and we are faced with more uncertainty than any other time in recent history.

The equity markets are only just starting to reach the levels they were at before the crisis, and the global property market has been turned on its head since the crisis, Van Deventer says.

Globally, interest rates, bond yields and inflation are at record lows and it is unlikely that the high inflation rates and high interest rates of the 1990s will return, he says.

Over the next decade things are likely to remain rocky, and it will be a really tough environment for investing and especially for those who need to draw an income from their investments, Van Deventer says.

In the midst of the uncertainty, you are likely in the years ahead to be bombarded by more bad news about investment markets than ever before, but the way in which you react to that news will be the key to your investment success. You may need to diversify your investments across a wider range of markets than before, and some active asset allocation will probably be the key to getting the best out of the low-return environment, Van Deventer says.

The most important decision you, your financial adviser or your fund manager can make about your investments is your asset allocation, Van Deventer says.

He says research has shown that 94 percent of the returns you earn is a result of asset allocation calls, while only four percent is a result of stock picking and two percent is a result of market timing.

When it comes to asset allocation, you need to consider what will drive returns in the new low-interest environment, Van Deventer says, and to do that you need to consider how the world has changed.

There has been a fundamental shift in our local investment environment and in the way growth is generated in the global economy, he says.

Acsis believes that if the global economy behaves as expected, the returns you earned from various asset classes over the past 10 years will be lower over the next 10 years.

For example, over the past 10 years, Van Deventer says, local equities generated real (after-inflation) returns of 9.22 percent a year, but acsis expects that over the next 10 years real returns will be around eight percent a year. (See other expected returns in the table. Link below.)

Van Deventer says although we like to stick with what we know, the reality is that the investment environment has changed, and if we want to achieve acceptable returns over the next 10 years, we will have to change the way we invest and not rely on investment calls that may have proved successful over the past decade.

Our brains are backward-looking and pattern-seeking, and our past experiences shape our expectations of the future. For this reason our instinct is to stick to an investment formula. Investing mostly in the local share market worked well over the past 10 years, but it is unlikely that this formula will generate the same kinds of returns in the foreseeable future, Van Deventer says.

He says the changes in the global economy also mean that it makes sense to consider asset classes, such as global shares, that did not fare so well over the past 10 years, to support your investment strategy over the next decade.

However, he says, when you consider the expected asset class returns, remember that if any of the key issues expected to drive the global economy changes, these projections may change.

‘Diversify into markets driving world growth’

To earn good returns in the future, you need to diversify into the markets that will be the engines driving growth, Henry van Deventer of acsis says.

Diversification will no longer mean just investing in, say, the United States. It will mean taking into account that the US’s contribution to the global economy has changed, and your offshore investments will need to reflect that change, he says.

If you consider the world’s 10 largest economies as an indication of the engine that drives the global economy, it is interesting to see what changes the International Monetary Fund (IMF) expects among these top 10 over the next five years.

According to IMF projections, the contribution of North America (the US and Canada) to the total output of the top 10 economies will decline from 37 percent to 32 percent (mainly due to Canada dropping out of the top 10).

The contribution of emerging economies (currently China, Brazil and Russia but in the next five years including India) to the top 10 economies will increase from 27 percent to 36 percent, Van Deventer says.

Meanwhile, Japan’s share will decrease from 13 percent to 11 percent and the share in the top 10 of key economies in the eurozone (Germany, France, the United Kingdom and Italy) will decrease from 23 percent to 21 percent.

Van Deventer says that in five years the emerging markets will make up the biggest slice of the top tier of the global economy but they will remain volatile. In addition, the fortunes of the emerging markets will continue to significantly influence our local market.

Developed markets will continue to make money but at slower pace than they have in the past, he says.

Van Deventer says developed markets will continue to grow but at slow and steady pace, like a chauffeur-driven car. Emerging markets, on the other hand, will be like a taxi, lurching forward rapidly at times and backtracking rapidly at times due to the greater effect of emotions and uncertainty to which these markets are exposed.

The new low-interest investment environment: what it means for you

The low-interest investment environment coupled with the changes that are happening in the global economy will make active asset allocation much more important for you, as an investor, than before, Henry van Deventer of acsis says.

Investors will benefit more by using actively managed asset allocation funds and targeted return funds in future rather than single asset class funds, he says.

Volatility will become a much bigger part of our lives, with seesaws in the price-to-earnings ratios of shares and more sideways movement on markets. The European crisis will continue and there will be a growing role for emerging economies, Van Deventer says.

You may have to adjust your investment strategy when necessary because financial planning is not like driving with a global positioning system. It is more like navigating a ship in the past, when you had to use the stars and landmarks to determine your position and constantly adjust your course in line with these, he says.

As the global economy changes, you may need to reposition your portfolio relative to the economic landmarks.

You cannot expect to earn returns from markets in a straight line. We are set to encounter times of bad market performance more often, and to be sure of earning positive returns from more volatile asset classes, such as shares and listed property, the periods over which you invest will need to increase.

If you are drawing an income from your investments, in the years with meagre returns you may need to temper your withdrawals – tighten your belt and not increase your budget if you can, and postpone big-ticket expenses, such as travel or a new car – to ensure the sustainability of your savings, he says.

Van Deventer says there are four factors that influence how long your savings will last you in retirement. You have control over at least three of them, namely, how much you save, when you retire and how much you spend in retirement.

The fourth factor is the only one over which you do not have absolute control: how much growth you get. But there are things you can do to ensure you get as much as you can.

One of these is to stay focused on the big picture – on whether the engine driving returns is still working – when you hear bad news about investment markets, Van Deventer says.

If it is, there may be little you need to do other than ride out the volatility.

If you are properly diversified within a suitable asset allocation, you need to realise that there may be times when your best reaction to market news will be to do nothing at all.

Van Deventer says it is human nature to want to do something when markets are performing badly. It is also human nature to react twice as emotionally to a loss than to an equivalent gain, and this makes investors inclined to want to disinvest from markets that are performing poorly, even when this may not be the right thing to do.