J.P. Morgan Asset Management lowered its 10-to-15 year outlook for investment returns compared to last year’s report. In February 2017, we highlighted J.P. Morgan Asset Management’s (JPAM’s) long-term return projections for a U.S dollar-based 60 percent equity/40 percent bond aggregate portfolio, which was about 5.50 percent to 6 percent. This year, JPAM lowered its 10-15 year outlook by another 25 basis points to about 5.25 percent to 5.75 percent.
The 2017 market rally was good for institutional investors — as we have noted here. And with a median return of 12.4 percent state and local public pension plans have essentially beaten the average return assumption of 7.52 percent used within the public pension plan universe.
However, any investor will tell you that past performance is not an indicator of future results. And JPAM’s forecast follows similar expectations about long-term returns over the next several years.
Other investment advisors join JPAM. Morgan Stanley strategists argue that the combination of an aging business cycle and the Federal Reserve pulling loanable money out of the market suggests economic turbulence ahead. Further, research conducted by the Vanguard Group points out there is a 70 percent chance of a U.S. stock market correction. “For 2018 and beyond, our investment outlook is one of higher risks and lower returns,” Vanguard noted in a December report.
The JPAM report further specifies that the elevated equity valuations, which come on the hills of the 2017 rally, and gradually rising interest rates flatten the stock-bond yield curve.
Of course, structural changes such as the recent federal tax reform may still help rejuvenate the 2017 market burst, with everything from the growth in consumer spending to trillions of dollars corporate America may start bringing back from abroad. Nonetheless, the analysis from major financial consulting firms suggests caution amid lower “new normal” yield expectations, which matters a lot as state and local pension plans heavily rely on the ability to meet their long-term return assumptions to pre-fund future pensions.
For example, between 2013 and 2015, the assumed return for local pension plans averaged 7.4 percent, compared to 7.7 percent for state pension plans. Yet these are still too high—public plans’ average actual returns since the end of the financial crisis have been underperforming relative to both the major market indexes like S&P 500 and their own return targets. This ubiquitous underperformance is partially reflected in depleting coffers and growing unfunded pension liabilities.
These market outlook updates matter. Public pension plans should use them to better gauge their long-term investment return assumptions and safeguard pension assets from the future market volatilities.