"If God is omnipotent, could he create a long-term active investment strategy fund that was so good that he could never get fired?," US-based quantitative investor and author Wesley Gray asked several years ago. 

Gray's data indicated that God would likely get fired - if God focused on picking investments that would deliver top decile (top 10%) returns over five years. After picking the stocks with perfect foresight and heading out fishing for five years, Gray found God's celestial clients would have endured drawdowns of as much as 76% in the interim. How many clients would have had the stomach to endure that?

We semi-regularly take a look back at what the return distribution for ASX industrials has been like over a five year period. It is an exercise that provides data points and context when considering risk and return.

We ran the numbers for the five years through to the end of August 2021, and found that:

• 17% of stocks returned more than 200% over the five years

• 40% of stocks disappointed with negative returns

• Share prices of the top decile averaged a 48% drawdown (looking at pricing every three months)

• Over 90% of the top decile had market caps of less than $1 billion

• The median total return was just over 29% for five years or 5.25% a year

Source: Equitable Investors, Sentieo

Some of the names in the top decile are well known "growth" stocks like Hub24 (ASX: HUB) and Pro Medicus (ASX: PME).

But there are plenty of names you may not have heard of - like IT recruitment and labour player HiTech Group (ASX: HIT) and medical diagnostic developer Proteomics (ASX: PIQ).

For context, the annualised total returns for both the S&P/ASX 100 and the S&P/ASX Small Ordinaries benchmarks were both around 11% - substantially higher than the median stock in this review.

The median stock would underperform indices over five years, if not for any other reason than simply because those indices would be rebalanced through the period in favour of the stocks that are performing.

Consistent experience

The distribution of returns in this period of review was similar to when we ran the same analysis back in May 2018, although in the latest numbers there is a slightly larger portion of stocks that have had negative outcomes (40% now versus 36% then).

These figures are also consistent with a US analysis of the total lifetime returns for individual stocks between 1993 and 2006, where Blackstar Funds found 39% of all stocks had a negative return and around 20% were "significant" winners returning 300% or more. 

Source: Blackstar Funds

Insights

Key insights we take out of the data presented here are that:

• There are great opportunities for active investors with longer term time horizons

• Patience and discipline are all important as even the greatest opportunities have a habit of making investors question their conviction at times

• We can't have the perfect foresight of a God but insight or an "edge" is required as the median stock has struggled to match index trackers.

• God's investment portfolio, with a five-year time horizon and perfect foresight, would be dominated by smaller stocks!

Author: Martin Pretty

Inflation continues to be the dominant economic theme across the globe for governments, central banks and societies at large. The notion of this being a "transitory" phenomenon has been replaced by a realisation that it is much more persistent and far reaching than previously acknowledged. In turn, this has elicited aggressive tightening of monetary policy by central banks in an attempt to tame price pressures. Markets expect policymakers will be broadly successful in achieving this objective. Helpful in this respect are signs that a number of pandemic-related issues, such as supply-chain blockages and labour shortages, are beginning to ease.

However, there are a variety of longer term, structural issues at play that should not be ignored as they have the potential to keep inflation elevated for a protracted period. This could further complicate the policy outlook, especially as the economic cycle looks increasingly mature. It's important to remember that the majority of these drivers were evident before policymakers rolled out Covid-induced stimulus packages. They may not be quashed by simply tightening financial conditions alone. It's therefore possible that inflation could become more ingrained globally, and while headline inflation rates may decline from their near-term highs, levels may stay elevated for longer.

Deglobalisation

A key facet of the mid-1980's 'Great Moderation' in inflation was increasing trade connectivity between countries and growing global interdependence. Ostensibly, developed economies benefited enormously from a liberation of the supply side. Technological advances, political reforms and economic stability allowed companies and governments to more cheaply access key inputs such as labour, raw materials and manufactured goods. 

In recent years, however, there's been a growing movement away from globalisation. Alarmed by China's increasing global clout, and spurred further by protectionist sentiments, the Trump administration began placing punitive tariffs on Chinese imports in 2018. President Biden has kept many of these tariffs in place. Similarly, political events such as the UK's decision to leave the EU and the embargos on Russian trade and investment are further evidence of the reversal of globalisation. At a corporate level, many firms have been moving towards shorter, more secure supply lines rather than simply the cheapest option. The pandemic exacerbated this trend. We're therefore seeing a reversal of the globalisation trend of recent decades that helped to keep input prices in check.

Demographic drivers

Interlinked with the deglobalisation theme is the evolution of demographic factors, particularly when viewed through the prism of global supply of labour. In the late 1970s, we witnessed the beginning of an upward trend in the global working age population (those aged 15-64). This was led by the baby-boomers and medical advances. It also reflected the liberalisation of global labour markets and access to previously untapped sources of workers. The expanding supply of global labour contributed meaningfully to downward pressure on wages. However, as the chart below shows, this trend has started, and should continue to, reverse. This will potentially lead to a larger proportion of individuals who have little or no productive output but who still consume. In short, we have a situation of reduced labour supply that isn't matched by a material let up in demand.

Global working age population (15-64 years), as a % of total world population

Source: UNCTAD e-handbook of Statistics 2021

Exacerbating this demographic trend has been a fall in labour participation rates in a number of developed market economies. There are various theories to explain this phenomenon. For example, large numbers of people unable to work due to 'long Covid,' early retirements and life preference changes. What matters from an inflation perspective is that reduced working age numbers, coupled with reduced participation rates, mean tighter labour markets and increased upward pressure on wages.

Greenflation?

An increasingly debated potential driver of structurally higher inflation is 'greenflation'. The movement towards a less carbon-intensive economy has been supported by tighter environmental regulations, as well as changing investor and corporate preferences. The result has been much reduced investment in traditional energy infrastructure in areas such as oil and gas. This is felt most acutely when exogenous strains are placed on fragile supply structures, as evidenced by the recent Ukraine conflict.

More broadly, it seems unlikely that the transition towards a greener economy will be smooth. Many projects, by their very nature and scale, could take decades if not generations to execute. The implication for energy markets is that they are likely to remain volatile, with potentially increased upside risks to the inflation outlook.

Putting everything together

Although there will be regional and country variations, headline inflation in most developed markets appears likely to peak in late 2022 or early 2023.

This will give some comfort to central bankers and government officials as it reduces the likelihood of a repeat of the early 1980s where more extreme policy measures were required to tackle excessive inflation.  Still, we think inflation will remain a recurring and persistent theme, which will be a significant departure from the trend of the past four decades. With structural patterns apparently shifting, it is crucial that investors consider this evolution when constructing portfolios and recognise the value of real returns alongside nominal equivalents.

Author: Adam Skerry, Head of Inflation Rate Management