The present situation of low interest rates for a “considerable time”, as Federal Reserve chair Janet Yellen puts it, creates a lot of pressure for both long-term investors and asset managers. There is no longer a risk-free rate on which to rely to comfortably fund our diverse endeavours and the consequences are slowly percolating through our industry and further afield. Fortunately, psychology has taught us how humans respond to shocks: reactions move along the Kübler-Ross change curve, which is often a topic of management seminars. The good news is that it gives us hope for the future.
Denial or frustration about our arrival in a low-yield world is still widespread in our industry, mostly among institutional investors who often have specific targets for annual returns or are subject to risk-averse regulations on asset allocation. Trying to lower management fees or climb the risk ladder while keeping a pure fixed-income allocation are, for instance, symptoms of this state of denial. As central banks intended, this reaction has certainly contributed to the transmission of lower interest rates and the tightening of risk premia, but it’s not a long-term solution for investors in search of yield.
Retail clients are probably still in a state of shock with the closure of money-market funds and retail banks beginning to discuss the possibility of negative deposit rates. Overall, investor morale is already fairly low.
However, we can also see the start of an “experimentation phase”, with renewed interest in asset classes other than fixed income, mostly in their least risky form. William De Vijlder, BNP Paribas Group Chief Economist, has recently argued against the most risk-averse allocations, reminding investors of the existence of an equity premium (see “Why worrying about stock market crashes can be costly”). Elsewhere on this blog, Raul Leote De Carvalho and Anton Wouters have shown that risk-managed diversified allocations can be an interesting alternative to money-market funds (see “How to earn more in a world of low interest rates”). Low-volatility strategies can also offer a way to close the cultural gap between equity and money-market investors. More globally, absolute return or flexible strategies are starting to attract assets, which obviously mark the start of a “decision phase”.
The real question is actually about the last section of the curve, the “integration phase”: what will be the effect of this zero-rate environment on other asset classes and on asset management as a whole? The commonly accepted view is that free cash should fuel the formation of bubbles and therefore spread the desolation. However, what we are currently seeing suggests there is also another effect: the arrival of more risk-conscious investors could have a positive effect on the conception of investment strategies for the riskier asset classes. Equity investors might start to assign more importance to risk measures that to past performance figures. The zero-rate environment could then turn out to be a good opportunity for our industry, and not just mark the end of returns.