GLOBAL - The extra returns for holding shares over risk-free assets will fall by nearly one third from present levels, making a reliance on equities by pension funds "a pretty dangerous strategy", according to new research by the London Business School.
LBS academics estimate the equity risk premium will contract from 4.5%, to around 3.1% in future. Each figure represents the extra reward for holding shares rather than Treasury bills, in return for the extra risk taken.
The co-authors of new research from the LSB, published today, calculate the cut in the risk premium by taking the 5.5% historic equity returns, then subtracting a 0.5% contraction in share multiples, a 0.8% contraction in dividend growth, and a 1% return from Treasurys.
Paul Marsh, co-author of the study which was sponsored by Credit Suisse Research, said the lower figure that resulted had "big implications for equity investing", not least for those paying active fund managers 1.5% to 2% for allocating their money.
"The risk premium will be lower. Although there are undoubtedly some active managers with extraordinary returns, if you would bet on active managers then going forward it will be little more than a zero sum game. For pension funds, banking on equity returns to bail them out of their deficits will be a pretty risky strategy," he said. "Believing the future will match the past is in itself optimistic."
The authors stood by calculations they made last year that emerging markets shareholders should enjoy a risk premium 1% higher than the average global premium for holding shares.
The uninspiring outlook comes at the end of what was already a disappointing decade.
The 0.4% annualized loss from equities over the period undershot the 0.1% annual gain from Treasuries and a 5.4% yearly gain from bonds.
However, since 1900 US shares made 9.4% a year including dividends, compared to 4.8% a year from bonds and 3.9% from bills. Annual inflation was 3%. For UK investors the equivalent figures were 9.5% from shares, 5.4% from bonds, 5% from sovereigns and 3.9% inflation.
The report found a persistent bias in some investment styles, and said investing in a mixture of them could magnify outperformance.
US small-cap investors, for example, made 2.6% more than large-cap investors per year since 1926 - a trend that has been mirrored in all but one advanced economy (Norway) since 2000.
Furthermore, value investors generated 3.6% more a year since 1926 than investors in low book-to-market stocks - mirrored in all but three advanced economies since 2000.
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