BlackRock: Low returns ahead
BlackRock’s return expectations are at post-crisis lows across asset classes, although the asset manager believe investors will be compensated for taking on risk in equities, selected credit, EM and alternative assets.
The world’s largest asset manager stated on its Q4 Global Investment Outlook report that equity valuations have risen to their highest absolute levels since the financial crisis.
Elevated equity valuations are usually a cause of concern but, in a low-return world where risk-free rates are expected to stay low for longer, high valuations “may make sense”, the asset manager said.
Equities, however, still look cheap on a relative basis due to the “precipitous drop in bond yields”.
BlackRock’s measure of the gap between expected returns on global equities and real government bond yields — a proxy for the equity risk premium (ERP) — still sits well above its long-term average (see chart below).
“In short, investors are still compensated for taking on equity risk in an environment where we expect very low returns across asset classes in the next five years,” BlackRock’s report reads.
The asset manager said this thesis could be undermined by a spike in bond yields — perhaps due to a rise in inflation and a steepening of the expected path of Fed rate hikes — would erode the ERP and diminish the relative attractiveness of equities.
Low returns rule the markets
Pension funds and other institutional investors aiming to meet long-term liabilities are being challenged in a low-yield world.
Yields on cash have been driven below zero in the eurozone and Japan — and are paltry to negative on government debt. Credit markets on the other hand offer comparatively attractive returns, albeit below pre-crisis levels.
Thus, investors are being forced to take on more risk to meet their targeted rates of return, which is pushing them into smaller asset classes, such as high yield and EM debt.
Slowing nominal GDP growth and aging populations argue for lower bond yields than in the past — and sustained demand for high-quality bonds.
“This structural shift changes the prism of assessing today’s valuations. It makes risk assets such as equities, credit, local EM bonds and selected alternatives look attractive on a relative basis,” BlackRock’s report reads.