After three decades of exceptionally high returns, performance drivers are likely to weaken or even reverse, says McKinsey. Investors should prepare themselves for decreasing returns over the next 20 years.
Despite the recent crises including the burst of the dot-com bubble during the first years of the millennium and the financial crisis of 2007 and 2008, investors have achieved a strong return on their investments. In fact, total returns in equities and bonds were significantly higher between 1985 and 2014 then the long-term average.
Looking at US and European equities, an average of 7.9 percent has been achieved over the 30 years before and including 2014 on both markets. Fixing income instruments such as US government bonds and European government bonds made an average of 5 percent and 5.9 percent respectively during the same time span.
These returns were achieved due to favourable economic conditions and strong business performance. With low inflation and interest rates, rapid growth in China and demographic changes, companies could rely on strong revenue growth. Decreasing tax burdens as well as productivity gains through automatisation and supply chain optimisation have further deceased costs. Overall, firms and thereby investors have experienced significant growth in profits.
The report “Diminishing returns: Why investors may need to lower their expectations” published by the McKinsey Global Institute finds that investors can no longer rely on the above mentioned factors to drive their investment returns. With interest rates and inflation having reached its lower boundaries, GDP growth can be expected to be lower over the next 20 years. Moreover, population growth and demand increases from China are no longer driving corporate profits. Only few developments such as further digitalisation seem to be favourable for corporations and their owners.
According to McKinsey estimation, equity returns could average anywhere between 1.5 and 4 percent annually over the next 20 years. For fixed income products, the report estimates an annual performance of 3 to 5 percent per year. Thereby, equity returns are expected to half while government returns will decrease slightly too.