![]() In this situation, the timing of returns becomes very important.Ĭonsider a hypothetical $1bn portfolio invested in the S&P 500 Index in 2000 and held for twenty years. As outflows from pension obligations exceed income from investments and contributions, they are cashflow negative, and the asset base is shrinking. Many pension plans have moved from accumulation to decumulation. When equity valuations have historically reached extreme levels like these, typically, volatility has risen, drawdowns have been more common and future 5-year returns have fallen (Figure 2).įigure 2: Very expensive valuations often indicate volatility ahead and lower future returns 2ģ) Drawdowns are far more painful in the "decumulation" stage 2) High valuations have historically meant lower returns, higher volatility, and larger drawdowns However, monetary policy stimulus is set to reverse course, potentially creating a significant adjustment in prices. However, equity valuations are now at or around their highest levels ever, at over two standard deviations above the long-term average, based on price-to-cashflow, price-to-sales and the Shiller CAPE index (Figure 1).įigure 1: Equities are very expensive relative to history 1Įquity performance has substantially outpaced growth in the real economy, sustained by very low central bank policy rates and quantitative easing (QE). In recent years, the extraordinary equity bull market has supported asset growth allowing many pension plans to erase their funding deficits. 1) Central banks have helped push equity valuations to record highs “An ounce of prevention is worth a pound of cure” – Benjamin Franklin. Three reasons to hedge downside equity risks
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