ARTICLES

While typically considered benign, passive index investing can come with unintended consequences.

During the last 30-40 year investment period, investors have been spoilt by an unusually favourable period for investments and asset prices. Following the high inflation and low growth period of the 1970s – when stocks and bonds did very poorly – inflation pressures finally subsided as did high interest rates. Furthermore, we had a massive period of peaceful prosperity and globalisation, enabling lower prices and greater economic efficiency. This created excellent conditions for most asset classes to flourish and with it growth orientated static Strategic Asset Allocation (SAA) portfolios and low-cost index funds.

Let us examine what happens when the clear and present danger from the coronavirus meets the global asset bubble, your portfolio and the industry standard investment approach. This is no small issue because – contrary to a market consensus – the coronavirus (COVID-19) is actually a real threat to complacent equity markets and client portfolios. It is a global health pandemic which requires active management in the real world, and which should also be risk managed by your adviser or super fund. The coronavirus and its real-world management should not simply be dismissed as just another flu, and could even be the catalyst which bursts the global asset bubble.

Many portfolios traditionally use government bonds and cash to be defensive. With bond rates and cash rates now at historic lows, there is no longer much yield or return that one can expect from a long-term investment in these. Furthermore, the likelihood of losing money over time in real terms is now higher, given it now requires little inflation to overcome the mediocre expected return from historically low yields. Unfortunately, such a situation reflects lacklustre economies and is the end result of market returns being pulled forward by government intervention. Traditional defensive investments have simply become a tool of government policy as governments attempt to prolong an ‘artificial’ economic expansion. 

The market environment has changed. Yet most advisers’ portfolios have not. They may want to adapt fast if they want their clients better suited to the new market environment - assuming they’re not going to unduly suffer more weak returns going forward as they did in 2018.

There is (arguably of course) a bubble in nearly every mainstream asset class. A bubble in debt markets, a bubble in property, a bubble in equity, a bubble in private assets, and a bubble in the way portfolios are managed. This is an artificially created result of easy monetary and fiscal policies that have been employed by global governments for many years now in an effort to boost asset prices (successfully). These policies appear unsustainable in the long term. If something can’t be sustained, then eventually it won’t be…

The recent equity market rally in response to dovish FED language again highlights how dependent equity markets are on government stimulus and sugar hits.

An alternative investment is an investment product other than traditional investments such as stocks, bonds or cash. 

The idea that we should invest to meet our needs and goals is basic common sense. However, somewhat surprisingly, that is not what most players within the investment industry do.