This much dry powder puts PE in a strong position to take advantage of any attractively priced opportunities that emerge in the aftermath of the pandemic and the consequent economic slump. However, the wall of money also means more competition for potential investments in a market where valuations are already stretched.
In aggregate, we expect PE to deliver returns of some 10.3 per cent per annum in dollar terms, which represents a premium of 2.8 percentage points to public equities. While this additional return is modest by historical standards – roughly half the long-term average – it is superior to what investors can expect from the other alternative investments we analyse.
Furthermore, the dispersion of returns within the PE universe is considerable: the best strategies can outperform the worst ones by more than 70 per cent.2
On the face of it, the performance prospects for hedge funds may look weak – we expect them to deliver just above 3 per cent total return per year. However, this is better than the returns hedge funds have managed to achieve over the previous half a decade. Given that virtually all traditional assets look expensive, alpha will be more important than beta over the next five years, which favours market-neutral strategies. Adjusted for volatility, we expect hedge funds to be among the best-performing altnernative asset classes because they typically have more flexibility to mitigate the effects of market slumps.
This characteristic will become particularly valuable as stock and bond markets become more volatile. We expect the volatility of a global 50/50 equity and bond portfolio to rise from circa 7 per cent in the past 10 years to about 10 per cent on average in the next five years.
This much dry powder puts PE in a strong position to take advantage of any attractively priced opportunities that emerge in the aftermath of the pandemic and the consequent economic slump. However, the wall of money also means more competition for potential investments in a market where valuations are already stretched.
Gold also offers investors some protection from increased turbulence in traditional asset classes. Quantitative easing, negative real rates, a weakening dollar and persistent geopolitical tensions should underpin demand for the precious metal. Inflationary pressures could also boost the gold price. Although we expect global inflation to remain modest over the next five years, monetary and fiscal stimulus will at some point begin to push prices higher. And when inflation finally arrives, there’s a substantial risk that central banks will be reluctant to step on the brakes for fear of causing another severe recession. In such circumstances, gold will come into its own as a store of value. We expect gold to reach a new all-time peak of USD2,500 per ounce by 2025, up from around USD1,960 at the end of July 2020.
Real estate also offers a degree of inflation protection, not least because rents tend to be linked to consumer price indices. With interest rates and bond yields around the world very low or negative, real estate will continue to attract strong inflows from investors looking for a positive real return. However, the influx of money may make it harder to find attractive investment opportunities – it is not yet clear, for instance, how the pandemic might affect demand for residential and commercial real estate, particularly in urban areas.
We are also positive on industrial metals, which could deliver a return of 5 per cent per year thanks largely to a sharp reduction in supply. Mining exploration has collapsed, with capital expenditure having fallen to levels of a decade ago. Production in Australia, meanwhile, is barely growing year on year.
We are particularly bullish on copper. Not only is copper in short supply but demand is sure to rise in tandem with the adoption of electric cars, for which the metal is essential. Prospects for cobalt are also positive, too. The metal is the most expensive component of an electric battery but is difficult to source – not least because more than half of known reserves are located in the politically unstable Democratic Republic of Congo.