Equities remain core investments for balanced and growth-oriented portfolios, even though prices have hit new all-time highs and euphoria is reigning in certain segments. Expansionary monetary and fiscal policy is driving valuations higher. The 25x price-to-earnings ratio of global equities, based on earnings for the last 12 months, looks high on the surface but needs to be put into perspective. It still equates to a 4% return – a handsome risk premium compared with the meager bond yields on offer. What is more, even in the pandemic-hit 2020, companies achieved a return on equity of 8%, indicating remarkable resilience. We avoid taking an overly mechanistic approach. With a simple value strategy, for example, you buy a basket of cheap stocks. However, this will include many that are priced so low for good reasons and that therefore cannot be expected to produce a resurgence. Traditional banks, for example, are no longer going to achieve the superior returns on capital that they once did. The energy sector faces massive transformation costs. IT hardware producers are only able to achieve low margins and are often interchangeable. Pharmaceutical companies without a promising pipeline or good acquisition skills do not promise future-proof growth. A selective approach is required – strong business models, good market positions, pricing power, intact growth, and decent balance sheet ratios – in other words, quality.
Real estate also promises reasonable returns, although it is often perceived as one of the losers from digitalization. The retail sector has been facing structural headwinds for some time due to the shift toward online retail; retail space continues to come under pressure. The office space is also being squeezed by the forced move to home working. However, the positive aspects should not be overlooked. Retail properties have lost significant market weight, and discounts to book values have been priced in. Only some groups of employees will continue to work from home, and the flipside of the coin is increased demand for private housing. The space required per employee is also likely to increase again, after years of shrinkage. In addition, there is a growing segment of global real estate that is benefiting from the digitalization megatrend, such as logistics properties, data centers, and mobile communications infrastructure. The evaluation of investments often focuses mainly on demand-side aspects. However, for real estate in particular, expectations of future supply are equally relevant. Many projects will not be realized, with a supportive effect on the available stock. Finally, the sizeable difference between net returns and the general level of interest rates will also play a decisive role in the future performance of real estate.
The low interest rate period, which is here to stay for the longer term, is giving gold good prospects of continuing to shine. If it is considered as an alternative to paper currencies, one can immediately see that central banks cannot increase the supply of this metal at will. That provides protection against inflation and stability in a crisis. The low interest rates do not just spell a lack of income; the contribution to diversification from this asset class will also be lower in future, meaning that other sources of return must be sought. Away from traditional asset classes, insurance-based investments deliver diversifying returns, which are especially attractive following the recent premium rises. Flexible, market-neutral strategies also make a portfolio more robust in difficult market phases.
It would be a bold claim to assert that there are far more profitable investment ideas than there is money available to invest. Nevertheless, with a reasonable investment mix, investors will still fare well in many scenarios.
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