Pension Plans Unlikely to Achieve Return Targets

According to the 10-Year Capital Market Return Assumptions report released by the BNY Mellon Investment Strategy and Solutions Group (ISSG) and BNY Mellon Wealth Management, ISSG analysis derives an expected return of 7% for U.S. large cap stocks and similar risk-adjusted returns for U.S. small and mid cap stocks annually over the 10-year period. These returns are propelled by real earnings growth of 2% per year, a dividend yield of 2.25% and developed market inflation of 2.5%. ISSG noted that the 2% earnings growth projection is significantly below the near-term consensus of 6% annually.  

In fixed income, ISSG sees real cash rates rising to approximately 1% annually in the U.S. in 10 years. ISSG said with inflation at 2.5%, it expects the 10-year Treasury yield to be 3.5%, causing long-term Treasuries to provide a negative return over the 10-year period.  

“Based on our research and analysis, we are projecting extremely low fixed-income returns and single-digit equities returns over the period, which will make it challenging for institutions to reach their target returns,” said Jeffrey Saef, managing director for BNY Mellon and head of ISSG. “If institutions remain intent on aiming for combined eight percent returns, they may need to seriously consider taking on more risk in their portfolios.”   

Expected returns for alternatives depend heavily on the underlying asset class, with a range of 3% to more than 11% for the category.   

The report notes that interest rate increases could adversely affect returns of fixed-income assets held by pension plan sponsors, many of which are underfunded. However, these same interest rate increases would also reduce plan liabilities, which might result in a net increase in funding levels. Concerned plan sponsors need to consider whether they need to add exposure to equities, and they could consider shortening the duration of their fixed-income holdings, the report says.