Asset allocation: I wouldn’t start from here!

russell-investments-wire-blog-graphic

A local Irish man once told a visitor “If I were going there I wouldn’t start from here”.

Financial advisers these days must be tempted to give the same advice to their clients. If we were able to choose the starting point of our long-term investment decisions I think everyone would be very careful to avoid today. In this blog I will attempt to put today’s market environment in a historical perspective.

My favourite “sweet spot” is 1989. A time machine would take me amid the rubble of the Berlin wall as the wind of change sweeps through the Moskva and a famous philosopher predicts the triumph of liberal democracy and the end of history as we know it. Moving to rather more mundane matters a UK investor at the time could have reaped double digit returns by simply parking his money in a savings account. Even adjusting for inflation, which at almost 8.0% was much higher back then than in recent years, a real return well over 4% was still on the table. Needless to say that on the back of such optimism about the new world order it would have been tempting to venture into equity investments. Surely the opening up of markets previously untouched by capitalism would provide plenty of opportunities to boost companies’ profits? With the benefit of hindsight, over the 10 years between 31/12/1989 and 31/12/1999 the UK stock market handsomely outperformed cash, returning around 15% nominal per year against a background of falling inflation and interest rates. US equities did even better (nominal 20% p.a.). This exuberance at some point became irrational (to quote Alan Greenspan’s famous speech) and paved the way for the end of the party. However this was far away into the future for the enthusiastic 1989 investor.

Given the remarkable ride of the stock market over the 1990s, equity valuations had become very stretched towards the end of the “roaring 1990s”. Hence one might think 1999 was a worse time to invest than today. However back then, with inflation starting to dip under 2%, a conservative investor could have earned a real return well over 3% on rainy day savings accounts or could have locked in a respectable 5.5% nominal yield by lending to the UK Government for 10 years. At the other side of the spectrum, while the US stock market ended up barely positive for the decade, betting on emerging markets equities would have earned double digit annual returns between 31/12/1999 and 31/12/2009.

If not 1999, surely 2007 must win the ugly contest of the worst starting point in the history of financial markets. After all, troubles brewing in subprime assets were signalling that a giant real estate and credit bubble was about to burst. However, back then UK banks started to offer rates approaching 6% as customers queued in front of Northern Rock branches and feared their deposits were no longer safe. Gilt yields were still fluctuating between 4.5% and 5% and, again with the benefit of hindsight, the dramatic correction in asset prices about to come was going to offer some of the best opportunities of a lifetime for long term investors to pick up cheap assets, most notably in the corporate bond space. As we will see in my next blog, even the environment for investors in 2007 looked positively benign compared to the challenges facing them today. What this means is the current valuation environment has important implications for our asset allocation choices for the future.

10-Year UK assets returns from different starting points since 1985
russell-wire-blog-graph-1

Source: Datastream using FTSE All Shares Total Return Index, UK Benchmark 10 Year Datastream Government Index
Mirko Cardinale, Head of Asset Allocation, EMEA

Mirko-Cardinale

  1. No comments yet.
  1. No trackbacks yet.

This blog is not intended for retail investors. The opinions expressed herein are that of Russell Investments, are not a statement of fact, are subject to change and, unless they relates to a specified investment, do not constitute the regulated activity of “advising on investments” for the purposes of the Financial Services and Markets Act 2000.

This material does not constitute an offer or invitation to anyone in any jurisdiction to invest in any Russell product or use any Russell services where such offer or invitation is not lawful, or in which the person making such offer or invitation is not qualified to do so, nor has it been prepared in connection with any such offer or invitation.

Unless otherwise specified, Russell Investments is the source of all data. All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate.

The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

Copyright © Russell Investments 2017. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

The Russell logo is a trademark and service mark of Russell Investments.

Issued by Russell Investments Limited. Company No. 02086230. Registered in England and Wales with registered office at: Rex House, 10 Regent Street, London SW1Y 4PE. Telephone 020 7024 6000. Authorised and regulated by the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS.