Nedgroup Investments PM: Low rates could account for 40% of equity returns


Interest rates have declined for almost 40 years, and low interest rates could have added 40% to investment returns during that time.

First Pacific Advisors managing partner Steven Romick (pictured above), who is a Citywire A-rated portfolio manager, said this during a Nedgroup webinar. He is a co-portfolio manager of the $1.1bn (R17bn) US dollar Nedgroup Investments Global Flexible fund, which is also available in South Africa as the Nedgroup Investments Global Flexible feeder fund.

‘I would argue that this downward trend to a zero cost of capital has been the single greatest driver of global stock market returns. Some analyses suggest that as much as 40% of the market returns have been due to lower interest rates over the last few decades,’ he added.

Romick’s comments come as inflation and interest rates rise, and investors expect the US Federal Reserve to raise rates for the first time since December 2018.

‘A lower discount rate increases the value of the future stream of cash flows and pushes terminal value higher, which drives equity prices higher.

‘In addition, with bonds [in the US, Japan and the euro area] yielding so little, investors have put on more risk in the quest for returns and tilted their portfolios away from bonds and towards stocks,’ he added.

US inflation is at a four-decade high
US inflation is at a four-decade high, which is no surprise because of the low interest rates.

‘Since the great financial crisis, there have been huge increases in fiscal borrowing and a general easy money environment. That set the stage for higher inflation,’ he said.

The pandemic worsened things, affecting the size and availability of the labour pool and causing supply chain disruptions while durable goods consumption rebounded. Adding to the inflation picture is that energy prices have risen sharply.

US inflation was 7.5% for the year ended January 2022. The eurozone recorded its highest inflation rate since the monetary union of 5.8% for the year ended February. Germany’s inflation reached a 29-year high of 5.3% for 2021.

‘Emerging markets have had very high inflation increases, with some countries recording double-digit levels while inflation has remained low in the large Asia economies.

‘The expectations for future inflation are higher than recent history. We believe that inflation will be higher in the next decade than the preceding one – something that is not currently expected,’ Romick said.

Since 2001, stocks outside the US have traded at an average discount of 13% compared to US stocks, Romick said.

‘Today, foreign stocks traded at a 33% discount – a 20-year low. We do not believe that the businesses we own outside the US are substantially different in quality and growth to justify such a wide discount. Thus our significant exposure to foreign domiciled companies.’