UpFront | Published in March 2017

Long-Term Return Assumptions Reduced Again, for 2017

By John Manganaro | March 2017
Sharing data from their “2017 Long-Term Capital Market Assumptions” report, J.P. Morgan Asset Management researchers say they expect marginally tougher investing conditions this year, continuing the trend of declining long-term return assumptions.

According to the firm’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.”

Some plan sponsors will opt 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,” suggests Anne Lester, head of retirement solutions for the global investment management solutions group. “They could consider investment strategy options that can make portfolio diversification easier and could provide participants with the opportunity to enhance returns through the use of active management.”

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. Further, expanding the investment opportunity set to include, for example, high-yield debt and a greater allocation to emerging market equity could help enhance expected return. Adding real estate, with its relatively low correlation to both equity and debt, could 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 vs. last year’s estimates.”

The J.P. Morgan research suggests that just one-third of participants are confident 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 that the best way for participants to access a diversified palette of investment options is through professionally managed portfolio strategies, such as target-date funds [TDFs],” Lester says. In short, target-date funds can help participants realize the true advantages of diversification all along the road to retirement.”

She is quick to point out that her employer’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.”

This means “not only investing in more asset classes but also having the opportunity to generate alpha,” she says.

“This can be achieved both through skilled managers—professional investors adept at security selection—and 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.”