Long-term investing is about the belief that fundamental value exists and that asset class returns tend to mean revert to their equilibrium level and rotate around it, within regimes.
Every regime is defined by its mean/equilibrium, based on economic and credit cycles (and depends on a number of factors, including monetary and fiscal conditions). Detecting market inefficiencies and misalignments around these trends is the essence of active management. Among the reasons behind the current misalignments are excessive risk taking (especially in the credit market) induced by Central Banks’ quantitative easing policies, inefficiencies due to the retreat of research coverage in some areas of the market (ie, Japan) and the emergence of crowded trades in relation to the “benchmark-sation” of the markets (with a high concentration of risk in certain components of the indexes, typically large/giant firms and in the sectors represented). Although these distortions may result in significant challenges for investors, they also open opportunities for active managers to add value for the long term.
With a long-term perspective, macroeconomic variables are the main drivers of interest rates and earnings growth and therefore of the asset returns. Among these variables, the most important with a long-term view are: demographics, productivity growth, debt dynamics and changes in labour force and in capital formation. We think that the underlying trends affecting these variables (ageing population, sluggish productivity growth, high debt) point to a low interest rate at equilibrium and to equity returns (and earnings growth) around the long-term trend (about 6.5% for the US market). This will translate into lower return potential for a balanced portfolio in the future compared to the last 10 years.
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