Inflation, market volatility set to reappear

Financial advisers should prepare for the return of inflation and market volatility in 2018 as cyclical forces gain the upper hand over structural trends, according to investment manager Vanguard.

Vanguard Asia-Pacific chief economist Qian Wang said in the long term, structural forces would dominate. This included weak demographics and slower productivity growth.

Speaking at Vanguard’s 2018 adviser roadshow in Sydney today, Wang also said investors should brace for low growth, low inflation, low interest rates and low expected returns.

“For example, the global 60-40 portfolio is going to generate about 5.5 per cent average return for the next 10 years, which is much lower than what we generated in the past,” Wang said.

Average returns had hovered at 11 per cent since 1970 and 8.5 per cent since 1990, with Wang warning the current environment would be very challenging.

“You can see that the elevated valuation, compressed graph and also the low interest rate is also putting the efficiency frontier of the expected return to a lower orbit,” she said.

“In addition, the efficiency frontier is much more flat, which means for every unit of risk that you’re taking, you’re not getting well compensated as before.”

These challenges might drive advisers to contemplate opting for new and aggressive investment strategies, such as flexible yield and return. Wang suggested this would generate similar or slightly higher than expected returns, but much higher volatility.

“Because this kind of tilt ignores the volatility between asset classes and eventually it becomes the inefficient portfolio,” she said.

“We will have higher inflation and financial stability concerns will need central banks to tighten and that will cause more volatility in the market.”

She advised investors to focus on the long term.

“The ultimate solution is not some radically new investment strategy, in our view, but controlling what is controllable, especially the cost, and staying diversified, disciplined and focused on the long term,” she said.

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