An interesting take on what the investor class needs to wrap its collective head around given the some new realities from Jean L. P. Brunel, chief investment officer at GenSpring Family Office:
Mr. Brunel argues that the classic link among the return premiums for bonds over cash and stocks over bonds still holds, but they are substantially lower because of the low interest rates set by the Federal Reserve.
Here is how it works. The return on cash is typically the expected rate of inflation plus some real interest rate that is derived from the rate a central bank sets to promote growth. The return on bonds is cash plus some additional amount to account for the duration of the bond. The return on equities is the bond returns plus some premium for the risk associated with stocks.
He noted that cash typically had a return of 4 percent, putting bonds at 6 percent and stocks at 8 to 9 percent. With cash now yielding zero, that has lowered bonds’ return to 2 to 2.5 percent and stocks to 5 percent. The problem, as he sees it, is that too many people are stuck on the old numbers.
“I don’t want you to read into this that we have precise information on real returns,” he said. “I could be wrong. It wouldn’t be the first time. But whichever way you cut it, the environment is radically different."
The above comes from a New York Times story. Brunel is from the family office world so you can bet the portfolios he allocates (or oversees) are as plain vanilla and buy-and-hold oriented as possible.
In my view, there are two ways for affluent investors to get around these new low return expectations, each comes with its own set of risks:
1. Tactical Asset Management (Maximizing the market's upside potential at the right time and missing as much of its downside as possible when the trend changes - this can be done but most do not have the tools)
2. Alternative Strategies and Asset Classes (This could encompass hedge funds or hedge fund-like vehicles that are truly non-correlated, master limited partnerships, futures, real estate, fine art, gemstones)
But again, these are not necessarily easy for the average investor to research, choose between and then deploy. Which is where professional help comes in. If 5% returns are to be the new norm for stocks, this kind of help will be more important than ever.