Date posted: 15/07/2019 10 min read

Wealth management: Navigating the new normal

Long-held principles of conservative investing are breaking down in today’s low-interest, low-growth environment.

In Brief

  • The current low-interest environment means investors have to take on more risk than in the past to achieve the returns they need.
  • Investors need to adjust their expectations, as double-digit returns are a thing of the past.
  • Risk management must also be more sophisticated than bonds vs equities, or local vs global shares.

By Zoe Paterson

Managing and increasing wealth may seem a hard task at the moment. The current low-return, low-growth environment is creating challenges for chartered accountants working to secure a sustainable financial future for themselves and their clients.

Inflation is constrained and the global economic outlook is weak. Not only that, but sharemarkets are overvalued, with price-earnings ratios above long-term averages.

Bond yields are at historic lows, and interest rates are at rock bottom.

While global growth rebounded in 2010 after the global financial crisis, momentum has slowed. The International Monetary Fund (IMF) is forecasting economic growth to moderate over the next two years, and plateau beyond 2020.

For investors, one of the most damaging consequences of the lower growth environment is that some of the basic principles of conservative investing are breaking down. Investors are being forced to take on more risk than they would have in the past to achieve the returns they need, says HLB Mann Judd partner Jonathan Philpot CA.

“Particularly for retirees who perhaps thought they had to be conservative and have a large portion of their wealth in term-deposit-type investments, their return has just been smashed,” Philpot says. 

How conservative investing went wrong

Six-month term deposits held with Australian banks hit a 17-year high in August 2008, paying interest rates of 7.5%, according to figures from the Reserve Bank of Australia. Two years later, rates had fallen to 4.1% and they have not recovered.

In March 2019, six-month term deposits were paying an average of just 1.9%.

In New Zealand, six-month term deposits were offering rates above 8% in the first part of 2008, according to Reserve Bank of New Zealand data. By February 2009, rates had dropped below 4%, and they have not nudged above 5% any time since. In March 2019, the rate was 3.26%.

“The people who were playing it safe, in fact, have probably been hurt the most over that period, because their actual returns from their investments have more than halved,” Philpot says. “At this point, going forward, it doesn’t look like they’re going to get much of a return.”

Investors with sufficient capital may be able to achieve their goals with an investment return of 3-4%, which would allow them to hold a large proportion of their wealth in less volatile, lower-return assets, Philpot notes.

“But most people’s goals are that they wish to live on a pension from their superannuation, and they also wish to preserve the capital balance of their super fund for their next generation,” he says.

“If you’re taking 5% out [of retirement savings] each year, first of all you need to get a 5% return. Then if you’re looking to preserve the real value of your superannuation for the rest of your life, you’re adding on for the effects of inflation as well. That might be 1 or 2% per annum, so all of a sudden you need 7% per annum return.

“If you’re needing a 7% per annum return, there is no way that you could have a large chunk of your money sitting in secure term-deposit-type investments. You are forced to take on equity risk.”

“If you’re needing a 7% per annum return, there is no way that you could have a large chunk of your money sitting in secure term deposit-type investments.”
Jonathan Philpot CA, HLB Mann Judd

Taking on additional risk may concern some investors, but Findex principal adviser Garry Loffhagen CA points out that even people who are approaching retirement have time to recover from future downturns.

Should you take risks at age 50?

“A lot of clients around 50 say ‘I’ve only got 10 years to retirement, maybe I should take less risk’. I try to push them and say you’re going to be alive for probably another 40 years. This is not the time to shut down the risk bank. You need to take some risk,” Loffhagen says.

“If you only invest in a relatively low yielding, low-risk portfolio, when you get to 70, 80, 90, you’re going to be well behind what you otherwise could have achieved.

“Even at 60 or 65, you’re probably going to be alive for another 30 years, so you should and you can afford to take some risk with a good chunk of your portfolio because you’re only drawing down a modest amount each year in retirement, and people in pre-retirement are not drawing down at all.”

Double-digit returns are behind us

Regardless of the level of risk they are prepared to take, investors will need to reset their expectations for returns, says Loffhagen.

“The days of double-digit returns are probably behind us for the foreseeable future and whilst every year or two you might get something like that, generally people should recalibrate their expectations,” he says.

“The days of double-digit returns are probably behind us for the foreseeable future… people should recalibrate their expectations.”
Garry Loffhagen CA, Findex

It may not sound like much but a 6% portfolio return – 3 to 4% above inflation – may be a reasonable figure for investors to target, Loffhagen says.

“If inflation stays low, then 6% for an annualised return for the foreseeable future is actually quite good. It’s a matter of recalibrating expectations so investors are not chasing returns of 8, 9 or 11% and in doing so taking on more risk than they should.”

Not only should investors expect lower returns; they should also expect to receive lower compensation for taking on risk than they may have done in the past, says Cambridge Partners financial adviser Todd Sutton CA.

For equities investments, Cambridge Partners generally favours smaller companies and value stocks (those that appear undervalued by the market) over large companies.

“In the past, investors have been rewarded for having those investments. Some of [the companies] do go under, that’s why they pay more,” Sutton says.

“What we have seen in recent history is that the difference between large-cap stocks and those two [small-cap and value stocks] in terms of actual returns is lower than before.”

The premium that investors can expect from holding shares compared with fixed interest assets has also reduced, Sutton says.

Cambridge Partners is recommending longer duration fixed income securities – such as bonds with durations of up to eight years – and higher credit quality than it did in the decade from 2000-2010. Back then, local fixed income and short-duration securities, such as one- to three-year bonds, were delivering investors stronger risk-adjusted returns.

Major asset classes: 10-year annual return (%,pa)Figure 1. Major asset classes: 10-year annual return (%,pa). Click image to enlarge.

More sophisticated risk management is needed

With changing expectations for risk and return, the tools that investors have traditionally used for asset protection are losing their effectiveness.

Cash rates are too low to provide a meaningful buffer against sharemarket losses. And government bonds, while still useful, are delivering yields too low to protect portfolios as well as they used to, says Perpetual chief investment strategist Matt Sherwood.

“In Australia, investing in government bonds is a strategy that worked amazingly well [in the past]. In the 24 years where Australia equity markets recorded losses since 1900, 19 of those years saw bond markets rally. Of the five years where both bond and equity markets fell together, losses in bond markets in three of those years was only a handful of basis points,” he says.

Currently, bond yields are low, making it more difficult to use bonds to diversify equity risk. In late April, 10-year Australian government bonds were yielding 1.76%, while 10-year New Zealand government bonds were yielding just below 2%.

“It needs to be far more comprehensive than just the bonds versus equities or the domestic versus global debate that people used to have 10 years ago. Risk management needs to be far more sophisticated,” Sherwood says.

Perpetual’s fund managers use three layers of defence to manage risk in their funds. First, they avoid overpriced investments, says Sherwood. Next, they diversify using assets whose returns have zero or negative correlation with equities, such as safe haven currencies, spread trades and duration. Finally, he says, they have explicit downside protection in the form of put options, which allows them to maintain participation in a rising market but provides protection against market volatility.

Popular but simple strategies used in the past, such as where investors allocated 60 to 80% of their investment portfolios to local shares and held the rest in cash for diversification, just won’t work any more, adds Loffhagen. This approach provided relatively healthy returns through the early 2000s, but from 2009 onwards it has not performed.

“Australian shares did alright initially, but in the past five years they’ve lagged international shares as the Aussie dollar has fallen in value, and cash and term deposits are not the earners that they once were,” he says.

Loffhagen encourages his clients to diversify their portfolios across asset classes including infrastructure, international shares and some hedge funds.

“If you’re diversified across more than Australian shares and cash, you’re getting a smoother ride and a better outcome,” he says.


The information in this article and the links provided are for general information only and should not be taken as constituting professional advice. You should consider seeking independent legal, financial, taxation or other advice that relates to the unique circumstances. CA ANZ is not liable for any loss caused, whether due to negligence or otherwise, arising from the use of, or reliance on, the information provided directly or indirectly.

Read more:

The psychology behind financial risk calculations

Different approaches to risk