Investors will step up risk in their portfolios in response to an expectation of low rates of return in equities forecast for the next 10 years, Charles S. Bath said Tuesday at the CFA Institute financial analysts seminar in Chicago.
Nominal returns on U.S. equities will be an annualized 6% to 7% for the next 10 years, said Mr. Bath, managing director, investments, Diamond Hill Capital Management.
“If we are looking at 2% inflation, we are looking at a 4% to 5% (annualized) real” or inflation-adjusted return on equities for the next 10 years, Mr. Bath said.
Both nominal and real returns will be below historical averages of about 9% and 6%, respectively, annualized.
Given that outlook, Mr. Bath said, “I’d rather be in equities than in bonds.” He did not forecast bond returns.
The equity market is moving into “an environment where future rates of return on equity are going to be much lower,” Mr. Bath said before the group of about 75 attendees.
“What is that going to mean for investors if they are facing an environment where pretty much every asset class provides low nominal rates or return, lower than historical average?” Mr. Bath asked rhetorically. “How will investors respond? … My guess is they will respond by trying to add risk to their portfolios.”
“The one hopefully silver lining in lower nominal rates of return is real rates of return are at least acceptable,” Mr. Bath said.
“We are talking about 6% (nominal) returns provided by the equity market (annualized for the next 10 years) vs. the historical 9%,” Mr. Bath said. “That is a pretty big haircut in expected future returns … But if inflation remains low for an extended period of time, your real rates are actually quite good … Here we can have an environment where nominal rates of return are very low but the real rates of return are at least acceptable.”
