(Publised in IFA Magazine, Issue 584, 31 January 2012)

For the first time in decades there is no such thing as a sure bet in investment markets. Of course, in reality there never was, but in investors’ minds the perception certainly existed. This perception will crumble for good this year.

For example, not so long ago, investors could safely rely on a yield of about 5 per cent plus from risk-free government bonds. Equities, property and alternative investments could then be used to increase investment risk and achieve returns upwards of 8 per cent to 12 per cent a year. Those days have gone, which leaves investors in strange and uncomfortable waters.

Investors are still coming to terms with this changed world and the need to look at options that might otherwise have been dismissed by risk-conscious investors.

With cash returns in most developed countries (ex-Australia) at, or close to, zero, there is probably only one asset class that can deliver what investors require – equities.

The notion that equities could be considered the last line of defence may be surprising. Given their 10-year streak of going nowhere, recent stomach-churning volatility and (most importantly) strong dependence on economic growth for success, investors understandably remain apprehensive about equities.

However, this is a difficult time to invest and there are no easy choices.

Looking at international equities, there are very appealing metrics at the company level, set against the backdrop of grim macro-economic conditions. In many sectors, the top-tier companies are earning very respectable margins and have the strongest balance sheets in many years.

Furthermore, the management of these companies have acknowledged the growth challenges ahead and are sensibly deploying capital where it is most rewarded; for instance, buying back their own shares.

The combination of share buybacks and increasing dividend yields can provide high single-digit return growth in earnings per share even with little or no top-line growth.

While this means there are good opportunities in global equities, the external environment cannot be ignored. The pace of global deleveraging shows no signs of abating, with too much debt still resting on the shoulders of consumers, governments or companies.

To further complicate matters, the risks emanating out of Europe are non-linear in nature – they have the potential to produce precipitous shocks to the system.

Most people, investors included, are not conditioned to analyse these kinds of events effectively, and most don’t even try. This attitude is behind the considerable apathy, low trading volumes and significant valuation discounts in equity markets worldwide.

Once all of these factors are taken into account, the most likely trend is for equities to continue on a slightly upward but highly volatile path. The desire – or need – to find a return, and a lack of compelling alternatives, will inevitably force money into equities.

Valuation support will also strengthen this trend. However, not all equities will benefit equally. The market will continue to ruthlessly segregate strong companies from those unableto prosper in this harsher economic environment.

For instance, certain retailers, European financials and media companies will probably never regain their previous highs, irrespective of the economic environment. Technological changes, capital destruction and equity dilution have irreversibly impacted on many of these companies.

On a positive note, perhaps the biggest contributor to returns this year will be changes in corporate valuations.

In the current low price-earnings environment, a small change in valuation can be significant. Take the case of a company trading on 10 times earnings. A relatively minor rise in valuation to 11 times earnings reflects a 10 per cent increase in share price.

The banking sector globally is an example of one that could rally strongly given its current low valuation on both an earnings and book value basis.

Such trends provide ample ground for diligent, fundamental investors to earn returns that are not reliant on better economic conditions or stronger corporate earnings.

A major advantage for international equity investment is its ability to cast a very wide net. This is crucial when searching for the few companies that have the strength, products and valuation dynamics to reward investors over the course of what is undoubtedly going to be a wild ride during 2012 and perhaps beyond.