Investment Return Expectations and Wishful Thinking

When it comes to strategy games, count me in. Bridge and Scrabble are two of my favorites except when it looks like I have little chance for victory. It's one thing to lose a hand or two but feel confident in a possible win. It's altogether depressing to know that recovery is unlikely. This happened a few days ago when my husband added an E, U, A and L to create a cluster of words that scored him sixty-seven points. Ouch. Even with lots of high point letters, I knew that besting his bonanza move was improbable. Each time we play, I begin on an optimistic note and hope for a favorable outcome until that moment when I know it's time to recast my calculations.

It's good to wish upon a star yet just as important to distinguish fantasy from fiction. That's why I was surprised to learn the results of a recent study of 400 institutional investors about their performance predictions. Carried out by State Street Global Advisors ("SSGA"), in conjunction with the research arm of the Financial Times, main takeaways from the "Building Bridges" study include the following:

  • Traditional asset allocation models may be unable to generate a long-term average rate of return of eleven percent, certainly without forcing buyers to take on more risk.
  • Forty-one percent of survey-takers expressed a preference for "traditional" classifications of asset exposures versus factor or objective-driven identifiers.
  • Eleven percent of those in search of closing "performance gaps" rank smart beta strategies as most important and 38 percent of institutional investors will employ this approach alongside other activities. "Significantly, three-quarters of those respondents who have introduced smart beta approaches found moderate to significant improvement in portfolio performance."
  • Enlightened decision-makers are finding it hard to get board approval of "better ways to meet long-term performance goals" and peer groups are slow to follow suit.
  • Eighty-four percent of pension funds, sovereign wealth funds and other asset owners believe that underperformance is likely to continue for one year.

As Market Watch journalist Chuck Jaffe somewhat indelicately points out in "An overlooked investment risk: wishful thinking" (May 18, 2016), long-term investors are daydreaming if they believe they can regularly generate eleven percent per annum. He quotes Lori Heinel, chief portfolio strategist at SSGA, as acknowledging the difficulty of achieving this number, given "a really challenging growth outlook, inflation environment, and a really challenging investment return environment." Notably, it was only a few weeks ago when the special mediator for the U.S. Treasury Department sent a letter to Central States Pension Fund trustees, denying a rescue plan in part because its 7.5 percent annual investment return assumptions were not viewed as "reasonable."

As I described in an earlier blog post entitled "A Pension Rock and a Hard Place," public pension funds, union leaders, taxpayer groups and policy-makers are navigating choppy asset-liability management waters. They are not alone. Corporate plans, endowments, foundations and other types of institutional investors are likewise challenged with getting to their destination and not crashing on the rocks. My unrealistic expectations might lose me a game. For long-term investors, there is serious money at stake and model inputs are being scrutinized accordingly.