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No escaping constrained return potential


Investment returns are expected to be subdued for some time, and it’s important for investors be realistic about what will drive the performance of self-managed super funds in the future.



Investment returns are expected to be subdued for some time, and it’s important for investors be realistic about what will drive the performance of self-managed super funds in the future.

AMP Capital’s projections for medium-term returns across a range of asset classes indicates the implied return for a diversified growth mix of assets has now fallen from 10.3% a year at the low point of the financial crisis in March 2009 to around 7.0% a year now.

There are a number of factors that are contributing to this outlook. These include slower growth in household debt, the backlash against economic rationalist policies of globalisation, deregulation and small government as well as rising geopolitical tensions. Aging and slowing populations, low commodity prices, technological innovation and automation, the Asian ascendancy and China’s growing middle class must also be taken into account.

Australian implications

Despite the subdued global outlook, the Australian economy remains in good shape and is still resilient to global shocks. Economic growth in 2016 is expected to be around 3% over the year – or around potential, which is a good outcome The Reserve Bank of Australia (RBA) has room to ease monetary policy further, the financial system is in good shape and public finances are under control, despite the slippage in the budget over the past five to six years. Export growth is solid thanks to iron ore, liquefied natural gas (LNG) and coal exports as mines and LNG plants have become operational after years of construction activity.

Services exports such as education and tourism have surged thanks to a lower Australian dollar and demand from China. But, the recent strength in the Australian dollar may complicate the transition from mining to non-mining led growth, if it continues. Housing construction growth is still holding up thanks to a prior surge in building approvals but non-residential building growth still remains soft. Consumer spending is tracking around average levels and confidence has improved. Employment growth has slowed from elevated levels in 2015 but is still reasonable and the unemployment rate has declined to a low 5.6% as the participation rate has also declined.

On the income side, the economy looks weaker because of low inflation and prior declines in commodity prices. Industries such as food and department stores are under intense competition and have slashed prices. Wages are also under pressure due to consumer job concerns, slow employment growth in prior periods, sluggish productivity growth and excess capacity in the labour market.

While commodity prices have improved, export prices are still well below the high levels recorded during the mining capex boom. Australia’s reliance on the commodities sector has meant that low commodity prices have reduced corporate profits and government revenue, which flows through to households. Underlying inflation is expected to remain low, and at the bottom end of the RBA’s 2-3% target band.

Risk assessment

The risks to Australia’s external imbalance are to the downside. The current account deficit has weakened over recent years, alongside the falls in commodity prices. The lift in mining volumes is providing an offset to lower prices. And the improvement in commodity prices recently has been positive for the terms-of-trade (ratio of export to import prices). But, the risks to commodity prices are still to the downside. Supply for commodities like iron ore and oil is still elevated at a time when demand is not lifting significantly. And a higher US dollar will also be negative for commodity prices. So, the risks lie with further downside to the current account deficit.

There are also plenty of potential global shocks on the horizon, such as weakening in Chinese growth, which could hit Australia and increase the cost of funding external debt.

There is also the potential for a cut to Australia’s credit rating, which could hit consumer confidence, which is positive, but shaky. However, the recent experience has indicated that weak sentiment hasn’t stopped consumer spending from growing at a reasonable pace. A long-term impact of a downgrade would be the increased pressure on the government to repair the budget by pushing through serious reforms.

Implications for investors

There are several implications for SMSF investors. First, have reasonable return expectations. The combination of low investment yields and constrained GDP growth indicate it’s not reasonable to expect sustained double-digit returns. In fact, we have been in a lower return world for many years. But it’s worth noting very low inflation is one reason why returns are low and real returns are still reasonable.

In this environment, a dynamic approach to asset allocation may be a way to enhance returns when the return potential from investment markets is constrained and volatile. It’s also important to focus on assets providing sustainable income to provide confidence regarding future returns.

 

About the author
Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.
Diana Mousina is an economist within the Investment Strategy and Dynamic Markets team at AMP Capital. Diana’s responsibilities include providing economic and macro investment analysis and contributing to the performance of the dynamic markets fund.

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In a world where market volatility and low growth are the new norm, asset allocation is more important than ever. However accessing asset classes globally and outside of the usual places in order to do this is difficult.

AMP Capital’s Dynamic Markets Fund (Hedge Fund) ASX Code: DMKT, an exchange traded managed fund, offers a low cost solution to global portfolio diversification with a real return objective.

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Access up to 80 global opportunities in a single trade

In a world where market volatility and low growth are the new norm, asset allocation is more important than ever. However accessing asset classes globally and outside of the usual places is difficult.

AMP Capital’s Dynamic Markets Fund (Hedge Fund) ASX Code: DMKT, an exchange traded managed fund, offers a low cost solution to global portfolio diversification with a real return objective.

Learn more

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Receive regular insights and marketing communications including a weekly update of tending news and market insights that are tailored for SMSF trustees and investors.
AMP's Australian operations are bound by the current Australian privacy legislation which outlines how organisations should manage and use personal information collected and held about their customers. AMP Privacy Policy
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