Participants Should Brace for Lower Returns

Over the past five years, equities have delivered an average annual return of 15%, which is not sustainable, says Jim Smigiel, chief investment officer at SEI in Oaks, Pennsylvania.

“We do not expect that to continue in the foreseeable future, perhaps even the next 10 years,” Smigiel says. “Rather, we expect equities to deliver annual returns in the 6% to 7% range, which is a decent level of return but not what investors have experienced.”

Bond returns will be muted as well, Smigiel says. “The last five years have delivered an annual average return of 2.5%. We expect 3% over the next 10 years,” he says. “Thus, looking at a portfolio of equities and bonds, it will probably deliver a return in the mid-single digits.”

SEI is not recommending that its investors take on a large amount of additional risk in order to boost those returns. Instead, the company is recommending that clients invest in some high yield and emerging market equities and bonds, but overall, SEI is “having the hard conversation” to reset clients’ expectations for lower returns, Smigiel says.

Smigiel also believes investors should buck the recent trend to turn to passive, low cost investments and consider actively managed funds. “If you can add even 50 to 100 basis points to your return net of fees, that is pretty meaningful. Every little bit helps,” he says.

Robert Johnson, president and CEO of The American College of Financial Services in Bryn Mawr, Pennsylvania, also expects that equity and bond market returns over the next 10 years could be significantly lower. He is hopeful that once investors catch wind of this, it will motivate them to save more. For younger investors, Johnson does not think they should dramatically change their allocations, as they have a long time horizon ahead of them.

However, older investors within 10 years of retirement are truly in the “red zone,” Johnson says. The worst thing they could do is to embrace more risk, he says. “If you are behind on retirement savings, there isn’t a whole lot you can do to make up the difference other than try to stay in the workforce longer, save more money, plan on a lower standard of living in retirement and delay taking Social Security” until the payments would reach the maximum.

Aash Shah, senior portfolio manager at Summit Global Investments in Salt Lake City, Utah, believes that in light of the projected lower returns, investors should build a “defensive portfolio.”

A defensive portfolio would consist of 35% of the portfolio invested in “20 blue-chip, low-volatility, dividend-paying, free-cash-flow paying stocks like Procter & Gamble, Intel and Microsoft, with no more than four stocks in any one sector,” Shah says. He believes investors should have another 25% of their portfolio invested in physical real estate.

Next, he recommends 20% in laddered, investment grade municipal bonds in large states that have high taxes, like California. “By laddering them, you can eliminate interest rate risk and benefit by reinvesting if the rates go up,” he says.

The next portion of the portfolio, 15%, should be in laddered intermediate government and high-quality, investment-grade corporate bonds, with the final 5% in short-term bonds with a one- to two-year maturity, Shah maintains.

Ron Madey, president and chief investment officer of Wealthcare Capital Management in Richmond, Virginia, agrees there should be a place for bonds in a lower-return environment in order to manage downside risk, noting that long-term Treasuries did “exceptionally well” following the Great Recession of 2008.

INTECH, however, believes investors should remain committed to stocks, says John Brown, head of global client development at the firm, based in West Palm Beach, Florida. The firm has developed an investment strategy whereby, rather than evaluating stock fundamentals, it looks at a stock’s volatility propensity, he says.

This doesn’t result in blazing outperformance, but it is designed for a defensive posture, and can reduce risk by 40%,” Brown says. “We think this approach makes sense, particularly for folks in a defined contribution plan because protecting on the downside is critical when you look at long-term compounding because the amount you need to get back to whole is less.”