Decade Ahead

Recent years have been dismal for real returns on cash, with higher interest rates not sufficient to offset the surge in inflation. Since the start of the decade, the real purchasing power of cash has fallen by 8% in US dollars, 13% in euros, and 6% in Swiss francs.

We expect cash to remain among the worst-performing major asset classes. A rate-cutting cycle is underway, eroding future returns on cash. Meanwhile, secular trends such as deglobalization, decarbonization, higher debt, and an aging population may put periodic upward pressure on inflation, eroding cash’s after-inflation returns.

We advise investors to shift excess cash deposits and money market funds into assets that provide higher and more durable sources of income.

Government bonds have had one of the worst five-year periods in modern history, with the Bloomberg US Aggregate Government bond index delivering a nominal negative return of 2.8%.

Conditions for government bonds have improved lately, with yields now higher and lower inflation and central bank rate cuts ahead.

That said, because of strains on public finances, investors may increasingly demand higher risk premia for government bonds. And while central banks may use their balance sheets to smooth financial market functioning, investors may need to prepare for greater volatility on longer-dated debt.

We believe investors should therefore supplement core government bond holdings with alternative sources of income, including investment grade credit, fixed income hedge fund strategies, or private credit funds.

Corporate debt has also faced headwinds in recent years amid rising rates, high inflation, and the shock of the pandemic. But prospects have revived amid stronger-than-expected US growth and healthy consumer and corporate balance sheets. We expect higher returns from corporate credit than in recent years.

We do see challenges in the years ahead, however, particularly as bond investors digest changes in investment needs, bond issuer profitability, and the composition of bond indices. But we believe a diversified allocation to credit remains a key part of a balanced portfolio.

Despite a challenging start to the decade, equities have delivered very strong performance over the past five years. Returns have been led by the US, with the S&P 500 returning around 111% over the period, at the time of writing. Technology stocks flourished during the pandemic and have gained an additional boost in recent years by advances in artificial intelligence.

While US equity market valuations are now higher than historical averages, we are positive on the long-term outlook for overall equity market returns. Over the coming years, we expect the commercialization of AI to benefit top US tech firms as well as other sectors and markets through higher productivity and profit margins. We also expect equities to suffer less of a drag from higher inflation than fixed income, since leading companies should be able to pass on higher costs through higher prices.

We believe equities will likely remain the key driver of long-term portfolio growth. We advise investors to maintain adequate exposure to developments in AI, as well as to ensure global diversification.

Annualized returns on global private equity so far this decade have outpaced those on global stocks, according to data from Cambridge Associates, and opportunities have expanded, as companies have delayed or avoided listing on public markets. Separately, private credit funds have expanded into areas vacated by bank lenders, with direct lending achieving higher returns than leveraged loans.

We expect continued strong returns from private markets over the next 15 years, with the highest absolute returns from private equity. We also expect a growing private markets opportunity set, given the scale of capital required for digitization and decarbonization.

For investors willing and able to tolerate lower liquidity and less transparency, alternatives have become both an important driver of returns and a portfolio stabilizer.

The UBS Bloomberg CMCI Composite Index has returned around 75% over the past five years, helped by rising global demand for energy and industrial metals. High inflation has boosted demand for commodities from inventors seeking a hedge.

Looking ahead, a range of long-term forces will likely affect the outlook for the asset class. Deglobalization could lead to regional scarcities. The shift to electric vehicles and continued investment in zero-carbon infrastructure should boost demand for a range of metals and minerals. And increased use of AI is boosting energy demand. At the same time, while gradual, the process of decarbonization should ultimately reduce the share of oil and gas in the total energy mix.

Overall, commodity volatility could be elevated in the years ahead, so we recommend a tactical and actively managed approach to long-term commodity exposure.

The US dollar has outperformed most major currencies in the decade so far. The trade-weighted dollar index has appreciated by around 10% since the start of the decade. Now, the US currency trades at strongly overvalued levels compared to most of its peers, in our view. We estimate purchasing power parity for EURUSD at 1.25.

Looking forward, we expect the forces that have supported the USD in recent years to fade, and large US fiscal and current account deficits could start to exert downward pressure on the currency.