Investing in a low-rate environment - how can advisers use CFA UK guidance to address growing conundrum?

    Moves in markets last year were extreme to say the least.

    Volatility across asset classes spiked amid the pandemic, and governments and central banks took unprecedented action to shore up economies.

    One policy tool used to help global economies fight back has been the reduction of interest rates to record low levels via ever greater bond-buying programmes.

    The impact in markets has been huge. For example, the 10-year UK government bond yield has decreased substantially.

    Having already dropped from 3.6 per cent in late 2010 to around 0.8 per cent by the start of 2020, last year saw it dive further, and currently it stands at just 0.2 per cent.

    Yields across the globe have followed a similar trend, with many even in negative territory.

    Dampened expectations

    The issue for clients is that, over this period, inflation expectations have remained relatively stable, taking the expected real return (after inflation is deducted) from 10-year UK government bonds to a loss of -3 per cent.

    With bonds traditionally a major part of most clients’ asset allocation mix, it means advisers and their clients are facing lower long-term returns as a result.

    Also, as government bond returns decrease, the total return demanded by investors for riskier asset classes such as equities and alternatives also falls.

    This means return expectations across all asset classes are lower than their historical average.

    The chart below shows the impact of this.

    It shows the efficient frontier (that is, the highest expected return for a set level of risk) plotted for interest rate levels 10 years ago versus today’s market conditions.


    Portfolio 10-year return expectations for different levels of risk (volatility) and market conditions. Net of portfolios charges.
    Source: Nucleus and Hymans Robertson illustrative only as at 31.12.20.

    Crucially, this change has occurred over a period where inflation expectations have remained broadly stable, meaning investors' expected returns versus inflation have been eroded.

    Re-evaluating client portfolios

    A recent report by the CFA UK on the impact of low interest rates highlighted the importance of managing clients’ expectations by using tools that reflect the market environment.

    The CFA also identified a number of ways to reconsider investing in this environment and how these may shape client conversations:

    Return expectations

    Are clients' return expectations reasonable given the low expected future returns offered on many assets?

    This is a crucial conversation which makes sure the client is aware of the change in investment outlook as a result of low rates.


    In light of the above, are clients' current contributions (or savings) sufficient to meet their objectives?

    The reality is, some clients may need to invest more to have the lifestyle they want in the future, so measuring the impact of lower return expectations on their projected future pension pot is a useful exercise.

    Risk levels

    Conversely, are some clients assuming too much risk in order to hunt for yield in a low return world? For example, are risks now higher than they were for traditional portfolios with high government bond weightings?

    With expected returns depressed, clients may require more exposure to higher risk asset classes to achieve their goals.

    Any such decision needs to be balanced with the impact on potential negative client outcomes.

    Risk management

    When considering risk, what are the limitations of risk model(s) in relation to the assets in which the portfolio is invested?

    Do they, for example, rely completely on historic correlation, volatility and drawdown data which may not hold in the future?

    When measuring portfolio risk and how this impacts client outcomes, it’s important to use a risk model reflecting the current economic environment.

    Asset class expectations and relationships are changing and it's worth understanding if and how your risk model accounts for this.

    Portfolio (il) liquidity

    How long would it take to liquidate a particular client’s entire portfolio? How much would it cost?

    How do those figures compare with the past, and is the level of exposure to illiquid assets still appropriate for the client’s needs?

    The liquidity problem has reared its head numerous times in recent years.

    As a result, conversations about liquidity and ease of access to cash must form part of any re-evaluation of portfolios.

    Jonathan Letham

    Head of IMX