I have suggested for years that zero and (now) negative interest rate policies that central banks have employed are stealing money from the savers to prop up the economy and it’s not working very well. One estimate I saw recently has transferred over 2 trillion dollars from the savers (retirees, pension funds) to lenders (governments, corporations) over the past seven years. Zero rates are forcing savers that would otherwise like to buy safe fixed-income into higher yielding equities. This misallocation of capital will likely lead to a major pension crisis during the next recession.

The essence of asset allocation theory is an ability to forecast what expected returns are likely to be in the future and positioning your portfolio to take advantage of where the best risk adjusted returns are likely to be. You need to understand this because it’s about what will likely happen in the future with returns rather than the past, which far too many investors look at before they buy and investment.

There are a handful of investment firms that I highly respect for their asset allocation methodologies and forecasting abilities. In Europe, GMO LLC is amongst the best having established their global quantitative based asset allocation team in 1988. From the perspective of the euro, expected returns for almost all asset classes after inflation is basically negative. When we look at the same type of analysis from Research Affiliates from the perspective of a U.S. investor, we see a similar set of poor returns. Where we see the potential for higher returns, the main part of those higher returns are coming from the expected strengthening in foreign currencies.

The expectation for returns, if you exclude changes in currencies, is for emerging markets to perform the best (3-4 per cent) after inflation. But the returns in emerging markets are about 50 per cent more volatile than the returns in domestic markets historically. Just look at what just happened to Turkey over the weekend and to any number of challenged regimes over the past few decades. South America has seen the most debt defaults to investors in recent decades. The Brazilian real has declined 50 per cent since 2013 and has recently rallied over 20 per cent since world oil prices bottomed and Rousseff has been impeached.

If expected returns are likely going to be very low for the next decade or so and where there are decent returns expected, a much higher volatility, you can see the challenges. The next global recession, which will likely happen in the next few years, should create quite a crisis for pension plans and savers in particular that have overweighted equities.

Sometimes, cash is king and even short-term corporate bonds with their very low yields are a good place to sit for a while until over valued equities decline to much better valuations. I continue to get more defensive the higher the market goes.

Watch the segment on BNN.ca: http://www.bnn.ca/the-global-crisis-continues-for-savers-1.528443