Low Returns and Expectations



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I recently attended the Roundtable for Consultants and Institutional Investors conference in Chicago held by Institutional Investor Magazine.  Large public funds, insurance companies, national consulting firms and money managers attend this conference each year.  This conference is very selective in who it invites each year.   

The major topics discussed were as follows:

The first day covered hedge funds/alternative investments.  There were not many hedge funds in attendance this year due to poor performance and lack of interest on the part of large institutions.  Alternative investments were discussed including private equity, leveraged loans, real estate, mezzanine lending, high yield bonds, emerging market equities and emerging market debt.  The general consensus was that alternatives must have a place in a portfolio given low interest rates and a fully valued domestic stock market.  The question was, since these alternatives carry increased risk to the portfolio due to increased volatility and illiquidity, what is the right percentage?  Many public pension plans are underperforming and feel compelled to add more risk but are apprehensive should this backfire causing them to go deeper in the hole.  The same applies to endowments and foundations that may stretch for returns to fund their spending policy.

No one had the answer except to say the decision varies by fund and the appetite of the investment committees and their respective boards.

The next day and a half covered investing in general.  The key topics were:

  •    Trend toward indexing versus active management.

As we know there has been a rather large movement of money into stock index funds in the last few years as active managers have found it hard to exceed their appropriate index.  This is not unusual after a large downturn in the stock market like 2008.  With all stocks severely depressed money started moving back into the stock market in early 2009.  As the indexes like the S&P 500 started to go up, more and more money poured into it further moving it higher.  A rising tide raises all boats.  There are high quality stocks in the indexes that have strong balance sheets and good cash flow, and there are low quality stocks that you probably would not want to own.  This phenomenon has happened before.  We are now at a point where the indexes are highly valued based on such measurements as P/E ratios.  We have recently seen active managers start to outperform the indexes as the market is now focusing on the high quality stocks active managers buy.  We expect this to continue going forward.

  •    Expected returns of stocks and bonds going forward.

A panel of large consulting firms did a survey of the eight largest consulting firms in the industry about what they thought the returns of stocks and bonds would be over the next ten (10) years.  The results for the S&P 500 ranged from 3.5% - 6.5% per year for the next ten years.  As for the Treasury market, the average was around 2.5% - 3.5%.  They all said it will be difficult for pension plans and endowments/foundations to achieve their goals over the next ten years without making adjustments to their asset allocation and their contribution rates.  We expect returns to be on the high side of these ranges, and we think that our clients can achieve their goals by using Dynamic Asset Allocation and alternative investments over the next ten years.

  •    The DOL fiduciary rule was discussed at length in one of the breakout sessions.

The Department of Labor has issued guidelines concerning conflicts of interest, or the “Fiduciary Rule”, for retirement accounts.  This will go into effect April 10, 2017 and all financial advisors and their firms have to be in compliance by January 1, 2018.  Firms and advisors have to “acknowledge their fiduciary status, adhere to the best-interest standard, and make basic disclosure of conflicts of interest if they want to continue providing conflicted advice under the fiduciary rule’s best-interest contract exemption”.  Some securities firms like Morgan Stanley are fighting the rule and are claiming they can recommend products that are in the best interest of their clients and still get paid a commission on the products they recommend.  Different products pay different commissions.  The DOL would like for the firms to charge the same fee no matter which product they recommend.  At Monroe Vos we have always acted in a way that complies with the fiduciary rule and we will continue to do so.

  •    Alternative investments added to defined contribution plans.

Some recordkeepers and consultants are thinking of adding alternative investments to 401(k) plans.  This idea is in its infancy but could get traction if returns in traditional asset classes stay low.

  •    Client expectation in a low return environment.

Consultants are seeing some clients becoming impatient about the low return environment which is causing them to not reach their goals in the short term.  They say clients want to try something different to achieve higher returns like adding riskier asset classes, extending the duration of their fixed income portfolio or increasing their allocation to different types of equities.  They are telling their clients to stay disciplined and be patient.  Monroe Vos has added alternatives to increase returns in client portfolios that can accommodate them from a risk standpoint.  We would agree and encourage our clients to be patient as we go through the current market cycle.  Last quarter we saw an improvement in equity returns as active management is starting to pay off.

Please see the attached Hoisington Investment Management Company “Quarterly Review and Outlook Third Quarter 2016”.  As always they make some very valid points about the economy and the effect of too much debt.


Jamison Monroe
Chairman & CEO
Director of Consulting