Last night I had a conversation with a friend who has been active in the markets for the better part of four decades. To say that he was confused by the current environment is something of an understatement. And the semi-permanent state of low interest rates over the last several years looks likely to be around for an extended period.
Like me, my friend is stunned that equites have been able to climb higher even as earnings have fallen off a cliff. Every other time in our careers we have seen earnings decline several quarters in a row share prices have plunged. Not this time. Investors seem to believe there is nowhere else to go, so money continues to flow into stocks.
The longer term implications are probably even more serious for individual investors. The low, almost nonexistent risk-free rate is likely to mean lower returns for many asset classes. Projections from strategists at firms such as BlackRock and GMO Asset Management call for returns for most asset classes that are well below historical norms.
The interwebs are full of advice on how to operate in a low-return world. It seems everyone has an opinion on how to make money in this ZIRP (zero interest rate policy) forever environment. The simple truth is that in order to meet your goals in this brave new world you have two choices: change your current lifestyle to save more money or take on more risk.
Most of us are will find altering our lifestyle a difficult, if not impossible choice so the answer is going to be taking on more risk. Richard Turnill, Global Chief Investment Strategist at BlackRock put it this way in a recent article: "Generating higher potential returns over the longer term will likely involve accepting more volatility or illiquidity risk, or focusing on assets with higher return potential."
But achieving investment success will require individual investors to shift their mindset. The buy-and-hold contingent is going to have to accept that buying even the cheapest index fund will likely not help you meet your retirement goals or put the kids through college. That is particularly true today when we are starting from fairly lofty valuations in a slow growth economy.
The days of a 10%-a-year upward drift bailing to the swing trade gone wrong are probably over for now as well. Controlling costs, slippage and taxes will be more important than ever.
One of the best ways to achieve your investment goals in this environment is to make the Trade of the Decade a much larger part of your plans. While you give up liquidity and have to adjust to a holding period longer than a few months, the simple truth is that the consolidation trend in small banks will remain in force.
Focusing on underperforming, over-capitalized banks that trade below book value should continue to be a winning approach. And narrowing your options to just those with an activist investor as a shareholder should increase your odds of high returns.
Individual investors, in particular, should also focus more on closed end funds. Buying discounted closed-end funds has been a solid high-teens return strategy for my entire career and should continue to be one for the rest of it.
Most closed-end funds employ some leverage and have above-average yields. If you have a fund with a 6% return and the discount to net asset value (NAV) narrows by 10% over time that's a solid mid-teens return. Again, limiting your selections to those that have activist-investor involvement should increase your odds of higher returns.
Lastly, I have mentioned several times recently that most individual investors should have larger exposure to real estate. Buying quality REITs during periods of market dislocation and then holding for something close to forever is another high-return approach to investing in the current low-return world.
I am highly confident that my big three real estate holdings, Brookfield Property Partners (BPY) , Colony Capital (CLNY) and Equity Commonwealth (EQC) , will deliver higher returns over the next decade than owning stock indexes or bonds.
The world has changed, but it remains to be seen if the change in permanent. Some think it is "lower forever" instead of "lower for longer." What I do know, however, is that buying assets cheaper and holding for longer is the best way to deal with a low-return environment.