By Tony Kaye, Senior Personal Finance Writer, Vanguard Australia
Reviewing the structure of your investment portfolio is an important and ongoing task that should ideally be undertaken at least once a year.
Doing so ensures your portfolio asset allocations remain aligned with your tolerance for risk and your broader long-term investment goals.
After such a tumultuous year on global financial markets in 2020, the value weightings of your current holdings may be out of kilter with your target asset mix and it may be prudent to recalibrate your portfolio.
But before making any rash investment decisions, your asset allocation strategy should consider the global economic landscape and the medium to long-term outlook for financial markets.
Read the economic signs
The global economic outlook and the likely behaviour of financial markets in 2021 remain hinged to COVID-19, and more specifically to health outcomes and responses.
Under more optimistic scenarios for COVID-19 vaccine effectiveness and coverage, economic output is likely to reach its pre-pandemic levels by the middle of the year.
Alternatively, less effective health outcomes will leave economies making only marginal progress from current levels.
In terms of asset allocation, this means investment decisions should necessarily take the current economic risks into account.
Indeed, country-specific economic growth rates will be varied over 2021, with some economies returning to their pre-COVID levels of employment and output faster than others.
To stimulate economic growth last year, central banks such as the Reserve Bank of Australia responded aggressively by cutting official interest rates to record lows.
This triggered a shift of investment capital out of lower-risk assets such as government bonds into higher-risk assets such as equities throughout the last year.
After falling sharply last February, global share markets surged through the remainder of 2020, with the U.S. market closing out December at a record high.
This at least partly explains why some investor asset allocation weightings may now be somewhat out of balance, especially if their target weightings include other asset classes such as bonds, infrastructure, property, cash and commodities.
How different countries respond to COVID-19 over 2021 will play directly into the operations and earnings of individual companies, which in turn will impact investment returns in those markets over the course of this year and potentially beyond.
In the recently released Vanguard Economic and Market Outlook, we noted that our outlook for global asset returns over 2021 and beyond is guarded.
High valuations and lower economic growth rates mean lower equity returns are likely over the next 10 years.
The expectation is for global equities to return between 5 per cent and 7 per cent per annum over the next decade, and for Australian equities to have a slightly higher return range between 5.5 per cent and 7.5 per cent per annum.
These forecasts compare with the higher double digit equity returns experienced during past decades.
On the fixed income front, interest rates globally are set to remain low despite the outlook for firming global economic growth and inflation as 2021 progresses.
While yield curves may steepen, short-term rates are unlikely to rise in any major developed market as monetary policies remain relaxed.
Bond portfolios, of all types and maturities, are expected to earn returns close to their current yield levels.
Follow the investment flows
Another tool in one’s asset allocation arsenal is to follow global and domestic investment flows.
Money flows are determined by both economic and potential investment return factors, and it’s evident from Australian Securities Exchange data that equity investors here continue to have a home bias but are increasingly directing capital offshore through exchange traded products such as ETFs.
In fact, last year around $7 billion of investor capital went into ETFs on the Australian share market that exclusively invest in ASX-listed shares, and about $7.1 billion went into funds covering equities in other countries and regions. (See Investors take ETF holdings to a record high).
Despite the marginally higher returns expectation for Australian equity, one’s asset allocation should avoid having excessive concentration risk and home bias.
It underscores the benefits of a globally diversified exposure in managing risk, particularly given the expectation for elevated risks in 2021 and a lower returns environment over the medium term.
Equities are likely to continue outperforming most other investments and the rate of inflation, with returns expected to be 3 to 5 percentage points higher than that of traditional bond instruments over the next decade.
That said, maintaining a broadly diversified portfolio that’s appropriately aligned to your goals and risk-tolerance is important, as is avoiding over-reaching for yield or return at the cost of unintended risk exposures. Fixed interest continues to play a key role in well-balanced portfolios as a buffer to volatility on equity markets.
In 2021, it will be important for investors to remain disciplined and focused on long-term outcomes, and to accept that current macro-economic events will likely translate into lower-for-longer investment returns.
An iteration of this article was first published in the Wealth section of The Australian on 26 January, 2021.
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Source: Vanguard January 2021
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