The runaway leader, with a remarkable 10-year growth of 411 per cent, is emerging market equities, but you must have a stomach for volatility.
Fiscal View: Fate shows who's boss, and emerging markets are it
Advising a client on how best to invest his money is not an exact science.
A few months ago, the world was looking fairly rosy, with most economists predicting growth in equity markets this year. The FTSE 100 index, which reflects the share price of the largest UK companies, rose to 6,087 in mid-February, up 2.6 per cent from its value only six weeks earlier.
Then came civil unrest in North Africa and the Middle East, followed by the Japanese earthquake and tsunami and its value fell 8 per cent by mid-March in bouts of panic selling.
It seems that whenever economists agree on the future, world events conspire to prove them wrong. The point is that forecasting short-term price movements is fraught with difficulty because of unpredictable events such as these.
Some asset classes will respond well to such events, like oil and gold, and some will respond badly, like equities. No wonder there is a large amount of inherent volatility in market prices.
As an illustration of how unpredictable markets are from one year to the next, analysis compiled by Cazenove Capital in the UK shows the performance of various asset classes over the past 10 years.
The runaway leader, with a remarkable 10-year growth of 411 per cent, is emerging market equities, beating Asian equities into second place which, itself, had a commendable growth of 223 per cent (see chart below). At the other end of the scale, Japanese equities and US equities managed a pathetic 8 per cent and 10 per cent, respectively.
For US equities, this performance corresponds to a miserly annual growth rate of just under 1 per cent, supporting many investors' view that they could have done better by leaving their money in the bank. This, of course, is true because cash in the bank, according to the Cazenove analysis, returned 46 per cent over 10 years. But, as ever, investment by hindsight, though much sought after by clients, is still the unattainable holy grail of the financial services industry.
The main components of any traditional portfolio are equities in mature markets, government bonds, investment-grade bonds and commercial property. Most of these asset classes are languishing at the bottom of the 10-year pile, which explains why many investors have failed to make much money in the past decade.
We all know the reasons for poor performance: first there was the dotcom crisis in 2000, when exuberant demand and greed drove share prices up to ridiculous levels that were unsupported by fundamentals. This was followed by a stockmarket crash when prices fell by 40 per cent over three years. Then we had a bull run for four years, followed by the credit crisis that wiped 30 per cent off stock prices.
The only way to have achieved a reasonable return in this period, without too much volatility, was to have included a fair chunk of Asian and emerging market equities, commodities, high-yield bonds and hedge funds, all of which are anathema to the traditional portfolio manager - too much risk, too much volatility especially for those who manage pension funds where caution is the operative word.
Equity performances in these markets were driven by rapid economic growth in China, the rest of the Far East (excluding Japan), India, Brazil and Eastern Europe. High-yield, or junk-bond, performances were driven by the voracious cash needs of companies and governments in Asia and emerging markets, and investor dissatisfaction with US treasuries and uncertainty about the euro. Where else can you park your cash when the mature market currencies are offering so little?
But the most important lesson to absorb from this analysis is not the total performance over 10 years, but the lack of consistency in performance from one year to the next.
Even with a runaway 10-year performance of 411 per cent, emerging market equities topped the table in only four years out of 10. And on only one occasion did it follow up its success with another one in the subsequent year, which emphasises that betting on last year's winner is not often a winning strategy.
Commodities produced an interesting set of figures. This asset class, driven by gold, industrial metals, oil and agricultural products, topped the table three times and bottomed it three times. Its 10-year performance of 144 per cent is very acceptable, but its volatility would upset cautious investors.
So what can the average investor learn from all this? If your aim is to make a lot of money over one year, I suggest that you get an evening job or work more overtime because you will not make it on these markets. In the long term, however, with a balanced portfolio that spreads risk across different asset classes, you can make a reasonable return.
Despite the difficulty in predicting short-term performance, there are plenty of experts that give it a go. Barclays Wealth is as good as anyone and is currently recommending UK clients to increase equity holdings in Europe and the US, and to decrease UK and emerging market equities, and UK government and investment-grade bonds (except inflation-linked bonds). Given the poor performance of European and US equities over the past 10 years, as illustrated in the chart, this is a brave but, credible call.
Bill Davey is a wealth manager at Mondial-Dubai.