In a new analysis, Zenith Investment Partners has forecasted a strong recovery in investment returns this year, off the back of subdued returns over the 2022 calendar year.
Lower yields and equity market volatility characterised the past 12 months, impacted by aggressive monetary policy tightening from the Reserve Bank of Australia (RBA0 and its global peers, aimed at curbing elevated inflation.
But according to Zenith head of asset allocation Damien Hennessy, higher yields, lower valuations, and the normalisation of interest rate conditions could spur a recovery.
“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,” Hennessy said.
Zenith’s long-term return expectations have been revised up from 1.5-2% for bonds and below 3% for credit a year ago.
The research and portfolio construction firm has now projected 4% returns for bonds and closer to 5.5% returns for credit.
“For typically defensive assets, that’s a big uplift in performance,” Hennessy added.
He said the firm continues to expect market volatility amid uncertainty over the length and scale of monetary policy tightening, but the initial shock has passed.
“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,” he continued.
“However, if inflation has peaked, and the negative correlation that markets have historically exhibited with shares and bonds reasserts itself, portfolios should prove much more robust going forward.”
Zenith’s head of consulting Steven Tang said return expectations for global equities have also improved, including across small caps and emerging markets.
“Portfolio return assumptions for a 60/40 traditional balanced portfolio are looking better than they have since 2015,” Tang said.
As a result, investment managers are likely to “allocate more to bonds and higher-grade credit”.
Tang continued: “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.
“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.”
Meanwhile, Australian equities, which were more resilient to equity market volatility in 2022, have maintained a “healthy weighting”.
But Tang conceded sharper than expected monetary policy tightening could “act as a headwind”.
