McKinsey Global Institute recently issued a new report discussing historical and future trends in investment returns. The report finds that the total returns to financial markets in the United States and Western Europe during the past 30 years significantly outperformed the long-term 100-year average.
According to the report, sharp inflation decline, falling interest rates, strong world GDP growth fueled by favorable demographics and productivity gains, and strong corporate profit growth are the key factors that drove the exceptional returns. However, these factors are weakening. Interest rates are likely to rise; an aging world population is expected to dampen GDP growth; and competition from emerging markets coupled with technological disruptions that remove barriers to entry is putting a significant pressure on profit margins.
These fundamental changes are expected to reduce investment returns over the next 20 years. The report estimates that total real returns from US and Western Europe equities over the next 20 years could be 1.5 to 4.0 percentage points below the 1985-2014 average. Similarly, fixed income returns could be 3.0 to 5.0 percentage points lower or more. These estimates have important implications for pension funds, especially public ones that still assume a 7.0-8.0 percent long-term rate of return.
To read the full report, go here.
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