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Data and Research January 9, 2017
Long-Term Return Assumptions Reduced Again for 2017
J.P. Morgan suggests ways retirement plan sponsors can help participants improve outcomes in a low-return environment.
Reported by John Manganaro
Sharing advanced data from their forthcoming 2017 Long-Term Capital Market Assumptions report, J.P. Morgan Asset Management researchers tell PLANSPONSOR they expect marginally tougher investing conditions during 2017, continuing the trend of declining long-term return assumptions.
“In an overall portfolio context, the return for a simple 60% world equity and 40% U.S. aggregate bond portfolio is expected to be in the neighborhood of 5.5% to 6.0%, roughly 75 basis points below our 2016 assumptions,” explains Anne Lester, head of retirement solutions for the firm’s global investment management solutions group. “Volatility forecasts are also marginally higher.”
According to J.P. Morgan’s assumptions, the combination of lower fixed-income returns, a decline in economic growth assumptions and reduced equity returns “pulls the efficient frontier uniformly down.”
“In fact, the major components of this 60/40 portfolio are among the asset classes with the proportionately greatest decline in return assumptions versus last year’s estimates,” Lester warns. “Plan sponsors face a stark choice once they have acknowledged the outlook for lower returns.”
Some plan sponsors will choose to stay the course—with participants contributing at their current deferral rates, often into relatively undiversified portfolios.
“Alternatively, they can take action to help improve retirement outcomes, such as encouraging participants to save more,” Lester suggests. “They could consider investment strategy options that can make portfolio diversification easier; and provide participants with the opportunity to enhance returns through the use of active management.”
Naturally, the firm is encouraging participants to save more and start earlier.
“We’ve said it many times, and it still bears repeating. The downgrading of our long-term economic growth and market return assumptions, combined with longer life expectancy, points to a heightened possibility of participants outliving their retirement savings,” Lester says. “Saving more is the most obvious and effective way to improve retirement outcomes.”
NEXT: Saving more simply a necessity
In this environment, J.P. Morgan continues to believe the best approach to encouraging saving is to actively place participants on a solid savings path through plan design options such as automatic enrollment and automatic contribution escalation.
“Many plan sponsors are concerned that participants might push back on any attempt to diminish their control over the contribution decision,” Lester notes. “Our research suggests, however, that most participants are in favor of, or at least neutral toward, these programs.”
Beyond saving more, expanding the investment opportunity set to include, for example, high yield debt and a greater allocation to emerging market equity can help enhance expected return. Adding real estate, with its relatively low correlation to both equity and debt, can help dampen volatility.
“The addition of such assets can help shift the efficient frontier up and to the left,” Lester says. “What’s more, compared with the major components of a simple 60/40 portfolio, return estimates for these asset classes have held up relatively well versus last year’s estimates. The goal, of course, is not simply to offer a broader range of asset classes within the core menu, which would leave the complex task of asset allocation to plan participants. Our research suggests that only about one-third of participants are confident in their ability to choose the right investment options from their plan lineups.”
A similarly small percentage are confident that they can appropriately adjust the allocation of their portfolios as they approach retirement, further bolstering the arguments for greater use of automatic plan features.
“We believe the best way for participants to access a diversified palette of investment options is through professionally managed portfolio strategies, such as target-date funds,” Lester concludes. “When the glide paths underlying these strategies are based on a consistently derived set of long-term asset class return, risk and correlation assumptions, combined with strategic asset allocation expertise and awareness of participants’ behavior and changing investment needs over the life cycle, these strategies can guide the allocation of assets over time. In short, target-date funds can help participants realize the true advantages of diversification all along the road to retirement.”
NEXT: A lasting role for active management?
Lester is quick to point out that the firm’s long-term capital market assumptions, by design, do not reflect returns to active management.
“They are estimates of index-based returns, intended to inform strategic allocation or policy-level decisions over a 10- to 15-year investment horizon,” she explains. “With a lower return outlook for most asset classes, and an uncertain period of U.S. presidential transition and potentially greater market volatility ahead, investors will need to embrace a broader opportunity set.”
Lester says this means “not only investing in more asset classes but also having the opportunity to generate alpha.”
“This can be achieved both through skilled managers—professional investors adept at security selection—and through tactical asset allocation: the ability to opportunistically shift assets across sectors, asset classes and regions as attractive opportunities present themselves,” she suggests. “And given the low correlation between the alpha and beta components of return, the active component can also help to diversify portfolio risk.”
Lester concludes that retirement plans, to succeed in promoting retirement readiness, must adopt automatic enrollment and automatic contribution escalation to encourage greater saving.
“Consider target-date funds as the plan’s qualified default investment alternative to help ensure that participant portfolios are broadly and effectively diversified—both initially and as participants approach retirement,” she says. “Select professionally managed target-date fund strategies with the potential to provide enhanced returns through both skilled security selection and tactical asset allocation.”
J.P. Morgan Asset Management’s full report is available for download here.