2018 Investing for long-term capital growth - October 2018
2018 OCTOBER: INVESTING FOR LONG-TERM CAPITAL GROWTH
Long-term growth solutions - October 2018
The expected rate of return on a portfolio of assets is difficult to assess in the investment planning process. The investor’s current contribution level will vary dramatically based on the expected rate of return selected. If you are too optimistic, the investor will end up with less purchasing power than required, but if you are too conservative, the investor will unnecessarily defer consumption, thereby reducing quality of life in his/her younger years. The future is by its very nature uncertain and we have at best partial information to inform our forecasts.
The long-term saver is primarily interested in the real, or after-inflation, rate of return. Inflation measures the general increase in prices over time. If the rate of return selected equals the inflation rate, the investor is merely protecting the purchasing power of what has been saved. It is only the real return that can be viewed as a ‘reward’ for delaying gratification, as earning a positive real return will enhance an investor’s eventual purchasing power.
A good starting point in setting prudent return expectations is to look at the very long-run asset class returns (Figure 7 below): growth assets (property and equity) produced a real rate of return in the 6% – 7% range; while income assets (cash and bonds) earned 1% – 2%. This implies an expected long-run real rate of return of around 5% p.a. for a typical balanced fund (assuming exposure of between 70% – 75% to growth assets and between 25% – 30% to income assets). Actual real returns achieved over the past decade were, in line with the long-term average, explaining why the typical balanced fund achieved a real return of 4.5% p.a. Coronation Balanced Plus, due to a positive active return contribution, achieved a real return of around 5.6% p.a. over the same period.
FIGURE 7 - ANNUALISED REAL RETURNS PER ASSET CLASS
After a sustained period of below-average returns, our 10-year forecast for local equity is now slightly above the experience of the last decade as a result of more attractive valuations. The strong performance from global markets has contributed to global equities outperforming local equities over the past decade and warrant caution in future expectations. Current market conditions, influenced by extraordinary monetary policy accommodation and relatively full valuation levels lead us to a lower return forecast range for both global equity and global bonds (as set out in Figure 8 here). However, it is reasonable to expect better returns from the average balanced fund over the next decade based on a more favourable outlook for local growth assets. Based on the mid-point of our 10-year return expectations and asset allocation on the composite index we use as benchmark for Coronation Balanced Plus, it is prudent to assume a weighted real rate of return of around 5% p.a. for the typical balanced fund.
FIGURE 8 - EXPECTED ASSET CLASS RETURNS
IMPLICATIONS FOR INVESTORS
Your expected real return will have a material impact on your future purchasing power (Figure 9 here). The ability to compound at a 5% real rate of return, as has been achieved by Coronation Balanced Plus over the last decade, increases your purchasing power by 1.63 times over 10 years and 7.04 times over 40 years. Being able to add an additional 2% p.a. over the average competitor fund improves purchasing power by 25% - 30% after a decade, and more than doubles purchasing power over 40 years.
FIGURE 9 - INCREASE IN PURCHASING POWER
THE VALUE OF ACTIVE RETURNS
Coronation, like all active managers, pursues the outperformance of market indices or benchmarks (net of the fees we charge and costs that our portfolios incur). Since the launch of Coronation Balanced Plus in 1996, we have added 1.3% p.a. to the returns produced by its benchmark (comprising a combination of indices representing local and global equities, bonds and cash), and 2% p.a. more than the fund’s average competitor. Both measures of outperformance are shown after the deduction of all our management fees and portfolio costs (refer here further details).
CORONATION’S LONG-TERM CAPITAL GROWTH SOLUTIONS
Coronation offers a range of funds specific to achieving long-term capital growth. These include both domestic and international multi-asset and equity-only funds as listed here.
We strongly believe that multi-asset class funds address the majority of investor needs and reduce the complexity of decisions the investor needs to make. They diversify risk across asset classes, reduce the risk of poorly timed asset allocation decisions, and allow investors to invest with a manager who has the skill and experience to invest beyond equities, bonds and cash into niche asset classes.
But not all multi-asset funds are the same. Different funds meet the needs of different investors. The level of risk that an investor is willing and able to take, as well as appetite for offshore exposure, will determine which fund is right for their needs.
For the more sophisticated investor who prefers to construct his or her own portfolio, we offer equity-only funds that can be used as building blocks: domestic equity-only-Top 20 and Equity, and international equity-only - Global Emerging Markets, Global Opportunities Equity and the more recently launched Global Equity Select. Details on each fund are included here.
In this issue, we discussed some of the guiding investment principles for the long-term. Compounding real returns over multiple decades provides investors with a much higher chance of reaching their goals, however it does require discipline and rational behavior.
Investing over long periods of time does not come without short-term challenges - especially during times of market stress and volatility. The ability to look through the noise and manage one’s own behavior will often be the determining factor when it comes to reaching your investment goals.