BOSTON -- Investors in the $11.4 trillion U.S. mutual funds industry should brace themselves for lower returns in the next few years as assets with good value are harder find after a five-year bull run, fund managers said.
"Caution", "danger", and "unsustainable returns" were the buzzwords at Morningstar Inc.'s annual investment conference held last week at the research firm's headquarters in Chicago. And these terms were applied equally to bonds and equities, domestic and international.
"If we are to rely on history as a predictor of future returns, we are likely to be intensely disappointed. Because the future is simply unlikely to be anywhere near the recent or even historical past," Ranji Nagaswami, chief investment officer of AllianceBernstein Investments, told the conference.
"Bonds are not likely to have returns in double digits. And relative to their long-term history, equities, too, are likely to return a lot less," she said. AllianceBernstein estimated that in the past two decades, equities returned a compounded 12.5 percent in U.S. dollar terms.
Story Continues Below
Low interest rates have lifted bonds as well as stock buybacks and leveraged buyouts, which have boosted equities, in the past four years. That has lifted valuations of stocks and bonds making them less attractive now, fund managers said.
Stock and currency valuations between the different regions are also narrowing, limiting the opportunities for outsized returns earned in recent years from non-U.S. investments.
"The tailwinds that we had for the last five or six years are diminishing. Overall, what we have today is a world somewhat closer in balance," said David Herro, chief investment officer of international equity at Harris Associates LP.
AMBER LIGHTS
Herro, who is Morningstar's top international stock fund manager for 2006, said the one-year 24.7 percent return posted by his Oakmark International Fund and the 31.6 percent return of his International Small Cap Fund were not sustainable and he would be "shocked" if they were repeated.
"Do not get used to returns with 2s in front of them, 3s and 4s. Do not even get used to mid-teens," Herro said.
The story is the same with emerging market equities, where China and India are raising interest rates in a bid to cool their red hot economies.
"Sooner or later, that's going to take a toll on their domestic economies. You've got to have your amber warning lights on there," said Mark Headley, chief executive officer of Matthews International Capital Management.
While mutual funds do not hold much subprime mortgage debt securities, the ripple effect the subprime mess would have on markets will have a bearing on fund returns, fund managers said.
"I don't think there's a mutual fund story here. (But) things like this change people's risk appetite in general and they become more aware of risk and less likely to take it on," said Jeffrey Gundlach, chief investment officer at TCW Group.
Some also saw private equity players' buyout activities cutting into the long-term returns of fund investors.
"Some of us are concerned that they are sometimes buying some superb businesses at too low a premium. And that means the public shareholders are in effect getting cheated out of the long term result that would have been terrific," said John Rogers, chief executive of Ariel Capital Management LLC.
© Reuters 2007. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters.
Editor's note:
Big Gains as Stocks Go Up ... Or Down! -- Find Out How
The 3 Best Income Stocks in the World
Buffett: The best book ever written on investing.
