Despite ultraaccommodative monetary policy, most advanced economies have not attained so-called escape velocity. •  The legacies of the financial crisis – in the form of debt overhangs – continue to exert a drag. •  The structural deficiencies in the major economies, such as under-investment, cast a dark cloud on future potential growth. But one thing that ultra-low interest rates over the past six years have clearly done is to depress returns, particularly in fixed income assets. •  US bond returns since 2009 has averaged 2.3% p.a. compared to returns of 5.8% p.a. over the past 20 years. This has contributed to a more challenging investing environment for government funds – namely pension funds, sovereign wealth funds, and central banks – many of which have significant allocations to developed market fixed income instruments. Mean reversion is a key tenet of investment theory – the expectation is that as interest rates normalise, returns should revert to pre-crisis levels. But the cliché that this time is different could well be true. Secular trends weigh on future economic growth, and consequently the real return on investment. Drivers of future economic growth What are the prospects for future economic growth? There are, in my view, four key drivers of long-term growth: deleveraging, demographics, productivity, and energy. Let me elaborate on each of them. First, deleveraging. Global balance sheets need to undergo significant adjustments. This is a structural issue that will take time to address.
To sum up the impact of the four key drivers of growth, deleveraging and demographics are quite unambiguously a dampener while energy appears a benign force. The long term trend for productivity is hard to predict. But even assuming a generally optimistic prognosis for productivity, it is quite likely that global growth in the next 20 years is likely to be lower than in the last 20. This means that returns from financial investments are also likely to be lower in the next 20 than in the last 20. Safeguarding long-term returns The modest outlook for long-term economic growth presents a major challenge for government funds to close the widening gap between their financing needs and investment returns. •  On the liabilities side, population ageing in the advanced economies will increase pension claims and place a heavier burden on social services such as healthcare. •  On the assets side, slowing global economic growth will constrain investment returns. There are three ways to narrow this mismatch between trends in assets and liabilities: •  The first is to reduce financing needs by lowering social expenditures or increasing fiscal revenues. Both are politically difficult to do. •  The second is to reach for yield by taking on various combinations of higher leverage, longer duration, and greater credit and liquidity risks. But the public perception and character of government funds limit their scope for aggressive risktaking.