This year’s Covid-19 outbreak, and the deep contraction in economic output caused by it, appears set to affect the outlook for major asset classes next year and beyond.

While many effects are expected to be transitory, some of the changes might be structural. With vaccinations looking likely to be rolled out in many countries next year, and as soon as possible in the Isle of Man, the speed of the recovery is a key question facing investors.

Next year is likely to be calmer than this one.

However, uncertainties around long-term, structural changes may keep volatility higher than before the pandemic.

That said, an analysis of prospects for leading economies and asset classes suggests that, with very low interest rates and rich equity valuations, total returns for core asset classes, like equities and bonds, will be relatively low over the next five years.

The expected returns for developed market bonds look poorer than seen in recent years largely due to the very low yield levels seen in many countries. Falling yields weigh much on the performance of the asset class.

For example, the nominal yields on 30-year government bonds in the eurozone and Switzerland are negative.

That means that the anticipated returns for government and investment grade bonds are negative.

In the US and UK, analysis suggests that performance is likely to remain positive, however downward shifts of late seen in the yield curve have compressed them below 1%. European and US high yielding bonds appear to offer returns of about 2-4%.

That said, adjusted for inflation, the returns for weaker quality bonds still hover a meagre 1% above zero. But if inflation climbs for a sustained period, realised returns on fixed income assets might be weaker.

Equities may find it tough to make substantial gains given their already elevated valuations on many measures.

Despite that, dividends and net buybacks of shares are expected to provide a stable income yield. Developed market equities could offer nominal returns of 5 to 7% annually over the next five years. Emerging markets may provide a risk premium of another 1 to 2%.

Equities still provide appealing investment opportunities due to their growth component; a valuable commodity at a time when the scope for central banks to raise rates and tighten monetary conditions appears limited.

A focus on selecting high-quality companies exposed to secular growth trends, such as healthcare and technology, can help provide long-term growth in a more challenging environment.

Technological change and sustainability are two areas that are benefiting in certain ways from the effects of the pandemic.

Social distancing has led more activities, whether work or leisure related, to move online.

The trend to more digitalisation and virtual experiences has been accelerated in the last year. This is likely to affect the outlook for real estate, transport, retail and leisure among other sectors.

Almost all the fiscal spending announced this year has a sustainable bias attached. Investing sustainably can offer long-term growth opportunities in the switch to a low-carbon era.

And with the popularity for investing in such assets rising, the momentum behind sustainable investments is likely to strengthen.

In the Isle of Man, the government is implementing a six- to 12-month programme to support and strengthen the island’s capital infrastructure projects, the climate mitigation plan and attracting tourism once borders safely reopen as well as moving towards a digital, green, safer island.

Persisting levels of volatility in financial markets that are relatively high, aided by uncertainty around the pandemic roll and geopolitical tensions, suggests that portfolio construction and diversification will matter more.

With income return prospects weak and limited scope for capital appreciation, the effectiveness of being invested in a traditional 60% in equities and 40% in bonds allocation seems to be slipping, pointing perhaps to managing assets in a more tailored fashion.

Allocating to private markets, hedge funds or gold seems one way to aid performance prospects through a diversified portfolio.

Private markets seem to offer plenty of investment opportunities in both equities and debt.

A high-volatility and low-return period could also favour hedge funds, notably in fixed income, despite their relatively poor performance in the last decade.

Depending on the strategy, hedge funds tend to be more or less correlated to equity markets.

The dispersion in the hedge fund investment universe has increased even more so than in public markets.

This means that an active investment approach is of paramount importance for investors looking to produce alpha.

Finally, gold continues to appeal as a solid portfolio diversifier.

With real rates low, and even negative in some places, the precious metal should continue to offer protection in case of rising volatility without being a drag on performance in quieter periods.

Pete Downey, Barclays