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A New Year with familiar challenges for investors

Vanguard | 16 December 2015


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While the investment environment is likely to remain challenging and at times volatile in the New Year, investors with discipline and patience should expect to be rewarded with fair returns over the next decade according to fund manager Vanguard Australia.

Vanguard Australia has released its 2016 Economic and Investment Outlook, presenting the global asset manager's views on the Australian economy and investment markets. The 30 page report also provides an overview of the global economic environment, inflation, monetary policy, interest rates and projected returns for the key asset classes.

This 2016 outlook is the work of Vanguard's global investment strategy team. Vanguard Head of Investment Strategy Group, Asia Pacific, Jeffrey Johnson, said:

While global growth will remain frustratingly fragile in 2016 we see a world not in 'secular stagnation' (little or no growth) but, rather, in the midst of a structural slowdown.

Vanguard's view is that the global economy will ultimately converge over time toward a more balanced, less leveraged, and healthier equilibrium once the debt-deleveraging cycle in certain markets is complete."

Vanguard takes a conservative approach to forecasting, with forward-looking asset returns presented in probabilistic ranges, as projected by the Vanguard Capital Markets Model (VCMM). This proprietary model combines economic analysis and financial modelling, incorporating a range of potential outcomes.

Simulations for ten-year returns of global equities remain largely unchanged in the last 12 months, and are centred in the 7% to 10% range. This is based on an equity portfolio consisting of 50% Australian equities and 50% unhedged developed markets ex-Australia.

Australian equity returns also have a median expected return in the 7% to 10% range for the ten-year period, which is broadly in line with historical returns when adjusted for inflation.

The return forecast for fixed income is positive but muted with the expected ten-year median return for the global market centred in in the 2% to 4% range. However, Vanguard argues that regardless of projected returns and the interest rate environment there is a clear role for fixed income as a diversifying asset class to offset volatility in equity markets.

Vanguard Economist, Alexis Gray, said that while the local economy had lost momentum recently, cyclical economic recovery is likely to emerge over the coming years.

Australia has been in the midst of both a structural and cyclical slowdown over recent years. This has been driven by a combination of slower credit growth, slower productivity growth and more recently, by a substantial fall in mining investment," Ms Gray said.

A cyclical economic recovery is likely to emerge as the drag from mining investment fades, however, in our view this is unlikely until late 2016 at the earliest. Our base case in 2016 is, therefore, 2% to 3% growth with moderate downside risks.

The low level of core inflation means the door is open for the Reserve Bank of Australia (RBA) to cut the cash rate further if the economy requires support. Importantly, any decisions made by the RBA are likely to follow close monitoring of Federal Reserve policy in 2016."

The 2016 outlook was developed with a clear link to Vanguard's long standing investment principles, which highlight the importance of creating a specific and realistic plan to meet personal goals, remaining diversified and minimising costs.

While Vanguard's outlook may have some bearing on strategic asset allocation decisions, it is not a guide to market timing or tactical asset allocation," Mr Johnson said.

"Often we see investors setting themselves up for disappointment by chasing future returns based on specific predictions, when they can benefit more from focusing on the things within their control, taking a long term perspective, and developing an appropriate asset allocation mix consistent with realistic risk-and-return expectations."

For more detail on Australian and global economic indicators, plus detailed asset class return simulations the full paper can be viewed at vanguard.com.au/vemo.