What are the chances you’ll meet your long-term return target over the next decade? If you ask Research Affiliates, the odds aren’t great.
In a blog post published this month, Head of Client Strategies John West and Asset Allocation VP Jim Masturzo tackled the probability of investors earning a 5% annualized real return over the next decade.
According to a combination of industry surveys and retirement calculators cited by West and Masturzo, the average and median annualized long-term expected returns were 4.6% and 4.4%, respectively, after adjusting for inflation.
But after modeling risk and return forecasts for several mainstream portfolios, the pair found that it was extremely unlikely investors would achieve these returns.
A classic 60/40 portfolio of stocks and bonds, for example, had just an 0.2% chance of hitting the 5% return target.
“From today’s vantage point with US bond yields exceptionally low and equity price-to-earnings ratios in the top decile of a 100-year history, future returns are likely to be extremely muted,” the authors noted.
More diversified portfolios performed little better. Research Affiliates’ replica of a typical public pension plan—with 24% of the portfolio in non-US assets and 6% in diversifying strategies—had only a 7% chance of achieving a 5% real return over the next decade.
The outlook for defined contribution plans was also bleak: Target date funds with retirement targets of 10 to 30 years were given 6% to 13% odds of hitting their return target.
Skillful active management, West and Masturzo acknowledged, could provide a performance bump—if an investor could 1) find truly skilled managers in the first place and 2) maintain a highly skilled roster for the entire 10 years.
“Only under the most heroic, and in our opinion, completely implausible, assumptions can manager alpha make a meaningfully sufficient dent to profoundly change the conclusion,” they wrote.
Another possible solution is alternatives—but with public and corporate pensions allocating an average of 20% to 23% to the asset class, alts would need to deliver significant outperformance to make up for the disappointing returns forecasted for the remaining four-fifths of the portfolio.
“Our portfolios aren’t really baskets of asset classes and underlying securities,” West and Masturzo concluded. “They are bundles of future financial hopes and dreams, some grandiose and some basic…We in the investment management industry owe—and our beneficiaries should demand—a reasonable assessment of whether [goals are] likely to be attained.”
The Allocator’s Dilemma