Staying a step ahead of the markets

Since the crisis lows of March 2009, simply capturing market returns (beta) would have been ample return for even the most demanding of investors.

This is unlikely to be the case in the years ahead, and a greater emphasis on 'alpha' generation (above benchmark returns) will be needed. Short of having a crystal ball to tell us when that will happen and how, how can we create a portfolio for that future?

Within equities, returns can be enhanced by focussing on markets where there is evidence of consistent alpha generation over a period of time. Emerging markets and smaller companies may be particularly interesting in this regard, but valuations will remain as crucial a factor as ever.

Real estate, particularly UK commercial property, is another area that we see generating solid above-inflation income, with good potential for capital gains at reasonable valuations and with a low correlation to other asset classes. The UK market is seen as a safe haven for many overseas investors, though this has already compressed yields significantly in this sector. Outside of London, there are also interesting opportunities with some cities showing signs of growth.

Eventually, returns for global financial assets are tied to the growth rate of the global economy, which have been falling for some years. The first decade of the 21st century was characterised by falling nominal growth (including inflation) but continuous robust equity returns. As we found out after the event, what would have otherwise been a period of slowing returns for financial assets was juiced by enormous leverage, which was funded through borrowing. The rest is history; a global financial crisis unfolded and financial-sector leverage unwound with dire consequence for the global economy.

The world is still struggling with a lack of nominal growth. Inflation in most parts of the world remains below central bank targets and real growth is in short supply. The long-term trend rate for annual growth in the US economy used to be about 3%, but may now struggle to maintain growth above 2%, while the Eurozone is hard pressed to achieve anything above 1%. Even the emerging markets that used to grow at double digit rates are resetting their targets. China now talks about 7% growth compared to 10% before.

With overall market returns being constrained by slower growth, historically low bond yields and elevated equity valuations, the hunt for alpha generation will be all the more crucial in the years ahead.

Rebecca Hughes is an executive director at Coutts

Coutts writes a regular blog for Private Client Adviser