Long-term return expectations more optimistic

Oksana Patron

2 March 2023

Although short-term challenges will continue to persist, the long-term return expectations are close to best in eight years, according to Zenith Investment Partners’ head of asset allocation Damien Hennessy.

He stressed that more optimistic return expectations were underpinned by higher yields, lower valuations and partial normalisation of policy setting.

“The forward expectations for returns for cash, credit and bonds in particular are all far better than they have been for a long time, as their starting point valuations have improved,” he said.

Although the 2022 year was the worst in over a century for a standard 60/40 portfolio, and bonds experienced one of their worst years on record, there was reason to be more optimistic, with the key factor being at what level inflation settled and what became the ‘normal’ level of interest rates, according to Hennessy.

“We do expect higher volatility than what we have experienced over the past decade given higher rates and inflation, less supportive liquidity settings and the likelihood of a more volatile business cycle.”

The return expectations for global equities, including small caps and emerging markets, also improved while the diversification benefits of unhedged global equities continued to shine through.

“There will be tactical calls on bonds, but at least real and nominal bond yields are much closer to fair value. Within the higher-risk portfolios where equity weightings are heavier, higher allocations to global small caps and mid-caps may be warranted,” Zenith’s head of consulting Steven Tang, noted.

“These are the asset classes or sub sectors that have sold off the most over the past 12 months or so, and once the threat of higher inflation and rates and recession risk recede, upside potential will emerge.”

Tang also stressed Australian equities didn’t suffer the same downturn as other equity markets in 2022.

“Although the structure of the domestic market has proven favourable in a rising inflation and interest rate environment, and we maintain a healthy weighting to Australian equities, there is a point at which interest rates start to act as a headwind,” he concluded.