Preoccupation with the ‘now’ undermines investor returns: Franklin Templeton

While ructions in US politics and persistent conflict in Europe and the Middle East have triggered many investors to take decisive – arguably knee-jerk – actions on their portfolios, they will be far better off riding out the current storms and pursing a medium- to long-term strategy on their returns, argues Franklin Templeton Institute head Stephen Dover.

“When it comes to wealth enhancement, the longer run is decisive,” Dover said in a just-released Investment Horizons report. “Many studies have shown that the strategic asset allocation decision, and adherence to it, determines the lion’s share of a portfolio returns and risk over time.”

Dover predicts a mix of “continuity and change” across capital markets over the coming years, led by a gradual decline in policy rates towards neutral.

He foresees continued high relative returns for dominant firms in growth sectors. The underperformance of value stocks is, further, likely to persist, “given the absence of a catalyst in the form of increased profitability”.

“In our analysis, slower corporate profit growth will likely lead to more modest equity market performance in coming years, particularly in the United States where already-elevated valuations will likely constrain the scope for multiple expansion as interest rates fall.”

Aggregate corporate profits are likely to fall to growth rates of around 5% to 6% per annum over the next few years, somewhat below the postwar average of 7.4%.

According to Dover, the US, “by virtue of better relative growth, innovation and profitability, will likely continue to offer compelling equity returns relative to other major markets”.

Change in capital markets will likely be driven by a slowing of global growth and falling inflation, permitting central banks to ease policy rates.

Duration fixed income funds will likely be the primary beneficiary of declining interest rates, with investors currently able to lock in attractive rates.

“Government bond markets, especially in the United States, offer what we consider attractive prospects for investors willing to extend the duration of their fixed income holdings,” Dover said.

With short-term interest rates predicted to fall around 2–3 percentage points in the US, UK and Eurozone, Dover predicts that return prospects in global government bond markets “look attractive over the next several years”.

The credit market is presenting challenges for investors, however.

“Returns for potential credit risk and downgrades… are mostly too low, diminishing the appeal of broad corporate bond indexes.

“Within credit… valuations are less attractive”, Dover wrote. “Both investment-grade and high-yield markets present historically tight spreads over government bonds. Too tight, in our view, to account for some increased risk of downgrades and defaults that will likely emerge as growth continues to slow.”

Dover concludes: “In a world of modest earnings growth, investors will likely continue to pay up for earnings visibility and growth. Secular themes, existing and new, will offer what we consider attractive returns to medium-term-oriented investors.

“We favour AI, robotics, genetics, electricity investment and digital finance as the most compelling themes in the coming few years.”