Making 8% per year, a realistic target?

When talking to clients and advisers alike there is always a strong desire to earn consistent investment returns around which one can plan an individual or family’s finances. The insurance and fund management industry still produces projections around assumed investment returns of 5%, 7% and 9%. Allowing for 1% costs this top rate would equate to an 8% net of cost return, which compounded gives a 27% return over 3 years and 47% over 5. How does this stack up with what is being delivered?  Trustnet lists over 20,000 funds available to UK retail investors.  How many funds can demonstrate they have beaten these targets? On checking last night of:

• 2304 onshore funds 272 beat this over 3 years and 171 over 5 years ,  150  of which can demonstrate these returns over both these time periods
• 524 Investment trusts 97 beat over 3 years, 75 over 5 years and 55 over both  periods
• 7414  pension funds of which 429 beat over 5 years
• 6097 life funds of which 309 beat over 5 years

Noting that a good number of the above target funds are either Asian or emerging equity funds, which would be considered too risky as a single investment strategy for private investors, what about mixed asset or multi strategy funds? There are:

• 1642 managed or mixed asset pension funds of which 24 beat the target over 5 years
• 1472 managed or mixed asset life funds of which none beat the target over 5 years
• 27 mixed asset investment trusts of which 2 beat the target over 5 years
• 672 mixed asset onshore open ended funds of which 18 beat the target over 5 years
• 391 mixed asset offshore funds of which 6 beat the target over 5 years
• 194 offshore UCITs  hedge funds of which 15 beat the target

So less than 10% of all funds out there have beaten this target and if you want a diversified strategy, you are down to just 65 funds on a 5 year basis out of a total universe of 4,400 multi asset or multi strategy funds accessible to UK retail investors.

How bad are the rest? Focusing on the 800 mixed asset pension funds that give 5 year returns on Trustnet of which  just 3% hit the 8% target, 10% failed to match a deposit account, 22% failed to match the lowest projection rate and 86% failed to match the mid rate.  That’s 84% of funds failing to deliver 6% p.a. after costs.

So has the last 5 years been a one off and will it get better going forwards?

The engine for most mixed asset funds has traditionally been UK equities and UK Government bonds. Despite a 67% increase in the FTSE 100 from its low point in 2009, ETFs tracking the FTSE 100 are up just 10% over 3 years and just 22% over 5 years. However it’s not all been bad news, UK Government bond ETFs are up 23% over 3 years, and 38% over 5 so pretty close to the 8% target.  Emerging market and Asian equity ETFs are up around 70% in 5 years, well over the target 8%, so there have been some good opportunities.

I very much doubt it will get any easier. Global economic growth looks like it might be slowing again despite record low interest rates and equity prices are no longer cheap after a steep rally.  Energy costs are stubbornly high sucking on corporate profits and consumer pockets and Government gilt yields are at record lows with 10 year gilts generating just 3.2%, even in the US and UK where levels of Government debt are off the scale.

Will emerging markets rise another 50% from here any time soon? Will Government gilts give a positive return for the next 5 years?  It’s not going to be easy for fund managers and the high costs of much of the industry will continue to drag. I doubt the fund statistics will look much different in 5 years time, the vast majority will continue to disappoint.

Projection rates need to be lowered to get investor expectations in line with likely outcomes and investors need focus on lowering costs and to look beyond the traditional 60/40 long only UK equity/bond fund and the many varieties thereof to earn more consistent returns. Worth noting that highest success rate was achieved in the UCITs sector where funds can be more flexible on asset allocation and use hedging strategies to capture and protect gains.

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