CEO agrees with many underwhelming projections but believes Talmudic-inspired strategy will continue to pay off
By James Burton
Considering the number of players in the industry who insist they do not have a crystal ball, the number of folk predicting the future can be surprising. Of course, flippancy aside, attempting to look ahead steers a lot of thought and portfolio strategy.
It’s why the overwhelmingly negative projections around the next decade of balance portfolio projections matter – and it’s positioned dark clouds over returns going forward.
As an investor – and CEO of Nicola Wealth – who believes in a different investment model to the traditional 60-40, John Nicola nevertheless takes this analysis seriously. According to his research, since the beginning of 2021, no fewer than six different major asset managers, two large institutional investors, and a plethora of economic and investment writers have reached the conclusion that future returns for both stocks and bonds will be well below historical outcomes.
He said: “The most optimistic of this group is expecting, after-inflation, returns for balanced portfolios to be about 3% over the next decade while much of the rest of this grim group is calling for returns under 2% net-of-inflation and fees.”
Morningstar, BlackRock, Vanguard, Research Affiliates and JP Morgan all offered their verdicts on U.S., developed and emerging market equities, as well as U.S. bonds. Nicola adjusted their return projections for inflation and fees, and then averaged the five groups into one result.
It showed that following a typical investor’s asset mix of investing 60% in equities (25% U.S., 25% developed markets, 10% emerging markets) and 40% in U.S. Bonds, the expected future return in 10 years’ time is just under 1.3% after inflation and fees.
In addition, Nicola highlighted Jeremy Grantham, the founder of GMO, a U.S.-based asset manager currently managing about $60 billion for families and institutions, and his predictions. Out of 10 asset classes, GMO finds only one that is expected to provide a positive real rate of return – emerging market value. By these estimates, a balanced portfolio made up of these asset classes is expected to earn about -3-4% annually for the next seven years.
The caveat, Nicola added, is that Grantham is a deep value investor and has been forecasting negative returns for equities for well over a decade. “It can be difficult for a value investor to make fundamental numbers such as private equity ratios and book-to-value resonate in a world where growth and technology have been so well rewarded.”
This provides just a glimpse of the CEO’s analysis. Nevertheless, the forecasted numbers are brutal. Broadly speaking, Nicola agrees with this gloomy projection, insisting that future returns for any asset class will always be less than ideal when one is starting from a high valuation.
“It can easily be argued that based on current prices, equity, bond, and real estate markets are all expensive,” he said. “However, when it comes to public equity markets we do not invest in countries. We invest in companies and we do not limit ourselves to public markets only. Long-duration bonds are not the only way to effectively invest in fixed-income assets. Real estate can offer strong future returns if one can find ways to add real value.”
So, what does Nicola do different – and how does it propose to address this future return problem? Rather than the 60-40 model – or variations such as 50-50 or 80-20 – the firm opts for an institutional-style approach that combines public market assets such as stocks and bonds with private assets such as real estate, infrastructure, private debt, and private equity.
Retail investors have been able to ape this approach via a simplified method called the Talmudic Asset Allocation, defined by Pinnacle Advisory as: Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep by him in reserve.
Nicola explained: “In today’s world of investment options this becomes a third in business, presumably both private and public, a third in reserves, which can be seen to be gold but for us, it is fixed income so interest can be earned, and a third in land, meaning income-producing real estate.”
Since January 2000, this approach outperformed beat a 60/40 equity/bond balanced portfolio by 1.5% per year net of fees or more than 30% annually and 35% cumulatively over the past 21 years. The challenge for this allocation model is finding the components at a reasonable price and with enough liquidity to use them.
With regards to real estate, Nicola’s initial solution was to form individual partnerships that allowed individuals to invest in separate real estate assets. In 2005, it moved to a pooled fund structure and now offer three Limited Partnership pools (LPs) in Canada, the US, and North American Development. All three LPs are open-ended and evergreen, and the company also invests in private debt (initially mortgages) and private equity since 1995 and 2008 respectively.
But will this model continue to work so well in the future given the daunting challenges presented by the likelihood of meagre returns? Naturally, Nicola believes it will and cites a number a reasons, including its direct access and disciplined balancing. He also said his approach represents added value.
He explained: “Private asset managers are more actively involved in the management of the underlying assets within the pools they are responsible for. This is especially true for real estate where property management, leasing, proper use of capital expenditures, financing, and value-add development all contribute to the bottom-line returns.
“We could always choose to invest in REITs as a proxy for real estate for our clients, but it would be difficult for our expert real estate team to add the value they do by owning the real estate directly.”