Despite investors in Asia seemingly warming to hedge funds, Northern Trust predicts they will underperform most other asset classes in the coming five years. This formed one of a wide-ranging set of forecasts in its ‘Capital Market Assumptions’ report, published yesterday.

The US asset manager and custodian has tipped an average annualised return of 3.4% for the Hedge Fund Research Inc Fund Weighted Composite Index over that period. That compared to predictions of 7.4% for private equity, 5.8% for global equities and 2.1% for global investment-grade bonds. Emerging-market debt was forecast to outdo other fixed-income investments, with an annualised 5.5%. 

Northern Trust expects to see single-digit returns for every asset class for the coming five years, thanks to slow growth and ultra-low interest rates, combined with uncertainty caused by the rise of populist politics globally (see table below).

The firm did caveat its forecast for hedge funds by saying these strategies vary greatly by risk exposures and alpha potential. Returns will be hurt by lower risk exposure returns and lower alpha, magnifying the importance of manager selection, it added.

As for private equity, Northern Trust said the asset class's liquidity premium was likely to fall given the increased interest in the asset class, as deals become harder to find. Hence, while academic research has suggested the premium has typically been 2.5%, the firm trimmed that to 2.0% this year.

DMs versus EMs

Meanwhile, Northern Trust expects emerging-market stocks to outperform their developed-market counterparts in the next five years, posting annualised returns of 7.3% and 5.4%, respectively.

Slow economic growth will dampen DM revenue growth, said the report. “But low financing costs and modest operational efficiencies – to help offset any increase in input costs – should support profit margins.” In addition, valuations are likely to remain high because most fixed income assets do not offer a compelling alternative in a continued low-rate environment, it added.

Meanwhile solid emerging-market growth – assuming there is no China hard landing – should support EM revenues, noted Northern Trust. “But we expect per-share income to come under pressure from continuing liberal share issuance policies and margin contraction from rising labour costs.”

Real assets

Northern Trust was generally positive on real assets, tipping natural resources, global real estate and global listed infrastructure to return 6.9%, 6.3% and 5.6% annually over the next five years.

“Natural resource returns benefit from a supply response to lower prices,” added the report. “Global real estate will face demand challenges, but returns will be supported by a diversified set of risk exposures. Global listed infrastructure will remain a highly valued bond-market proxy.”