For the past several years, a cocktail of subdued inflation, declining bond yields and expanding valuations have helped deliver heady returns to investors. However, political turmoil, potential confrontation with North Korea and catastrophic weather are just a few of the factors that have reduced capital market return expectations, and the strong returns investors have come to expect might fall short.
A low-return environment would pose a challenge to investors in the years to come, jeopardizing financial goals while forcing them to make tough choices on funding, spending, return targets, asset allocation, and portfolio risk and complexity.
Our research suggests many investors are unaware of the possibility of low returns. Half of the defined benefit plan sponsors we surveyed last year expect returns of at least 7%. However, our five-to-seven-year assumption for a portfolio consisting of 60% stocks and 40% bonds is just 4.8%. Many institutional investors have a long-term time horizon that allows portfolios to withstand shorter-term volatility, but we still recommend investors consider altering investment programs to ensure their potential returns can meet long-term financial objectives.
Investors should consider several approaches to potentially maximizing investment outcomes in a low-return environment and choose the one (or ones) that best fits their time horizon, goals and comfort with risk. Depending on specific financial situations, they may be able to take advantage of liability-driven investing opportunities, total return opportunities and incremental opportunities.