Expect slower medium-term returns

October 21st 2020

turtle on a log

Key points

  • The continuing decline in investment yields on the back of falling interest rates and bond yields has seen our medium-term (5 to 10 year) return projections for a diversified mix of assets fall to around 4.8% pa.
  • At least it’s still better than sub 1% bank deposit returns.
  • The key for investors is to have realistic return expectations, allow that inflation is also low and focus on assets with a decent and sustainable income.



Despite a 35% or so plunge in share markets earlier this year; on the back of the pandemic and rough patches in 2018, 2015 and 2011, well-diversified Australian investors have seen pretty good returns over the last 10 years. The median balanced growth superannuation fund returned 5.8% pa over the five years to August and 7.3% pa over 10 years and that’s after fees and taxes. While that’s dull compared to the double-digit returns of the higher inflation world of the 1980s and 1990s, it’s pretty good once low inflation of 2% pa or less is allowed for.


slower returns graph 1
Source: Mercer Investment Consulting, Morningstar, AMP Capital


However, investors need to allow that past returns have been boosted by a search for yield as interest rates have collapsed, which has pushed down yields and pushed up values for most assets. But this, in turn, points to eventually constrained returns.


Investing 101: lower yields = lower return potential

It’s pretty obvious that investment returns have two components: yield (or income flow) and capital growth. Also, the price of an asset moves inversely to its yield all other things being equal. For example, suppose an asset pays $10 a year in income and its price is $100 – this means an income flow or yield of 10%. If interest rates on bank term deposits are cut this will likely encourage increased investor interest in the asset as investors will like its high yield. Its price will then be pushed up – to say $120, which given the $10 annual income flow means that its yield will have fallen to 8.3% (i.e. $10 divided by $120). This is great for investors who were already in the asset as its value has gone up by 20%. But its yield is now pointing to lower potential returns going forward, unless the yield continues to fall, further boosting capital growth – but there is a limit to this.


The plunge in yields since the early 1980s

In the early 1980s, the RBA’s “cash rate” was around 14%, 1-year term deposit rates were nearly 14%, 10-year bond yields were around 13.5%, commercial and residential property yields were around 8-9% and dividend yields on shares were around 6.5% in Australia and 5% globally. This meant investments were already providing very high income so only modest capital growth was needed for growth assets to generate good returns. So, most assets had very strong returns and balanced growth; super fund returns averaged 14.1% in nominal terms and 9.4% in real terms between 1982 and 1999 (after taxes and fees).

But with the shift from very high inflation to very low inflation, the last 40 years has seen a collapse in yields. This was led by falling interest rates and bond yields and then yields on other assets were pushed down too as investors searched out higher yields which pushed their prices up and their yields down. Just as the GFC gave this a push along so has the coronavirus pandemic’s hit to the global economy. See the next chart.


slower returns graph 2
Source: Bloomberg, REIA, JLL, AMP Capital


Today the cash rate is 0.25% (and likely to fall to 0.1% next month), 1-year bank term deposit rates are 0.75%, 10-year bond yields are 0.75%, gross residential property yields are around 3%, commercial property yields are around 5%, dividend yields are around 4.5% for Australian shares (with franking credits) but they are 2.25% for global shares. This points to a lower return potential for a diversified mix of assets.


More constrained capital growth

What’s more, the capital growth potential from growth assets is likely to be constrained relative to the past, reflecting a number of megatrends, some of which have been reinforced by the coronavirus pandemic:

Of course, continuing technological innovation and automation, as well as rapid growth in Asia and China’s middle class, will likely work to boost growth. But the net impact is likely to be more constrained global economic growth.


Medium-term (ie, 5 to 10 year) return projections

Our approach to getting a handle on medium-term return potential of major asset classes is to start with current yields for each and apply simple and consistent assumptions regarding capital growth allowing for the above-mentioned megatrends. We also prefer to avoid forecasting and like to keep the analysis simple.


slower returns graph 3
Source: Global Financial Data, Bloomberg, AMP Capital



Our latest return projections are shown in the next table. The second column shows each asset’s current income yield, the third shows their 5-10 year growth potential, and the final column their total return potential. Note that:


slower returns 4
Source: AMP Capital


Key observations

Several things are worth noting from these projections.


slower returns graph 5
Source: AMP Capital



Implications for investors


1 Adjustment can be made for: dividend payout ratios (but history shows retained earnings often don’t lead to higher returns so the dividend yield is the best guide); the potential for PEs to move to some equilibrium level (but forecasting the equilibrium PE can be difficult and dividend yields send valuation signals anyway); and adjusting the capital growth assumption for some assessment regarding profit margins (but this is hard to get right). So, we avoid forecasting these things.


If you have any questions about this please contact us.

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About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.


Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.