{"id":69952,"date":"2018-03-14T01:42:00","date_gmt":"2018-03-14T00:42:00","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/how-realistic-are-return-expectations-really-february-2018\/"},"modified":"2018-03-14T01:42:00","modified_gmt":"2018-03-14T00:42:00","slug":"how-realistic-are-return-expectations-really-february-2018","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/how-realistic-are-return-expectations-really-february-2018\/","title":{"rendered":"How realistic are return expectations really February 2018 ?"},"content":{"rendered":"

Two recent research papers triggered the question of whether it is possible for equities and
\nreal estate to structurally produce returns higher than underlying economic growth.<\/strong> <\/em><\/p>\n

\u2022 US pension funds assume extremely high future returns<\/p>\n

\u2022 Past returns boosted by high dividends, rising earnings<\/p>\n

\u2022 Neither seem to be repeatable in the decades to come<\/quote><\/p>\n

Although this is indeed feasible, future returns may not be as generous as they have been in
\nthe past, says Daalder, Chief Investment Officer of Robeco Investment Solutions.<\/p>\n

The first research paper, entitled \u2018The Return Expectations of Institutional Investors\u2019, looked
\nat the long-term expectations of 230 US pension funds. According to the study, their
\nnominal average expected return is 7.6%, resulting in an expected real return of 4.8%. This
\nis based on long-run average nominal returns on cash (3.2%), bonds (4.9%), real estate
\n(7.7%), hedge funds (6.9%), publicly traded stocks (8.7%) and private equity funds (10.3%).<\/p>\n

Somewhat ambitious<\/strong><\/p>\n

\u201cThis looks pretty ambitious given that historically, OECD data shows that the average annual
\nrealized return that these US pension providers over 2006-2016 was 1.5% in nominal terms
\nand -0.3% in real terms,\u201d Daalder says. \u201cAnd that was despite the average total return of
\nthe S&P 500 coming in at 6.9% during this timeframe.\u201d<\/p>\n

\u201cGiven the continued decline in productivity seen in recent decades, as well as the popularity
\nof the secular stagnation school of thought, it raises the question of how realistic the return
\nexpectations for the riskier parts of their portfolio really are,\u201d says Daalder.<\/p>\n

\u201cBy way of comparison, Robeco\u2019s own long-term (steady state) expected nominal return on
\nequities is 7%, while bonds are expected to yield 4.25%. As such, you still need a pretty
\noptimistic view of the world to get to a 7.6% longer-term return envisaged by these pension
\nfunds. Even when ignoring the early February stock market correction, recent performance
\nclearly does not support these kinds of return expectations.\u201d<\/p>\n

Link with economic growth<\/strong><\/p>\n

Daalder says it begs the question of whether there is a direct link between economic growth
\nand asset returns that would make forecasting more reliable. He says the answer to that
\nquestion partly comes from the second piece of research, entitled \u2018The rate of return on
\neverything, 1870-2015\u2019. In this study, the authors look at the historical track record of the
\nnominal and real returns of 16 developed nations since 1870.<\/p>\n

\u201cThe picture in this study is clear: with the exception of the two decades that marked the
\nworld wars, returns have been quite clearly in excess of the underlying real growth rates of
\nthe 16 countries studied,\u201d Daalder says. \u201cThe average real growth rate over the period was
\n3.1%, while the diversified portfolio return was 5.9%. But there is a catch.\u201d<\/p>\n

\u201cLooking at the breakdown of the portfolio used, it is clear that all of this so-called \u2018excess\u2019
\nreturn came from the risky assets: the returns on cash (1.3%) and bonds (2.5%) on average
\nlagged the growth of the real economy, while the returns on stocks (7.0%) and real estate
\n(6.7%) exceeded it.\u201d<\/p>\n

\u201cBased on these historic returns, the 4.8% assumed real return of pension funds all of a
\nsudden does not appear to be too outlandish after all. However, this outcome raises a
\nnumber of questions, led by asking how is it possible that returns on risky assets can
\nstructurally outstrip growth.\u201d<\/p>\n

Role of dividends<\/strong><\/p>\n

Part of the answer lies in the role that dividends have played in generating the \u2018excess\u2019 return
\nmade in equities and real estate in the past, Daalder says. According to the Shiller database,
\nthe total geometrical nominal return for the US has been 8.9% since 1871, while the average
\nannual dividend yield over that timeframe has been 4.4%. <\/p>\n

\u201cAs such, this seems to be a valid and stable reason to expect returns in excess of growth,
\nwhich can be seen as compensation for the risks involved with equities compared to risk-free
\nassets such as bonds and cash,\u201d he says.<\/p>\n

\u201cThe story doesn\u2019t end there, however. Stock prices have also risen more than the underlying
\ngrowth rate of the economy, adding to the excess return recorded in the past. This is partly
\nbecause there is a structural mismatch between the earnings growth of listed companies \u2013
\nwhich only represent a small subset of the economy \u2013 and wider economic growth.\u201d<\/p>\n

\u201cMeanwhile, higher levels of leverage, and exposure to growth outside the 16 reported
\ncountries (the emerging markets), are all factors that can lead to higher earnings growth
\ncompared to GDP growth.\u201d<\/p>\n

Too much wealth will lead to lower future returns<\/strong><\/p>\n

Daalder says another problem with future expected returns is that rising PE levels over many
\ndecades mean that stocks have structurally become more expensive over time.<\/p>\n

\u201cYou only need to look at the very low yields that we currently see in the bond market to
\nmake the point: these low future returns have come on the back of above-average returns
\nas bond prices were bid up. You see the same process in real estate and equities: you get
\nabove-average returns on your investment as stocks and houses are being bid up, but this
\nleads to a reduction in future dividend yield or rental returns.\u201d<\/p>\n

\u201cWhich brings us back to dividends being an important part of the excess return we have
\nseen in the past. The long-term dividend yield has been 4.4% for the US, but if we look at the
\ncurrent dividend yield of the S&P 500, this has declined below the 2% level. Given the
\nimportance of dividends in the \u2018excess\u2019 return, it is pretty safe to say that from this starting
\nlevel, one should not expect the same returns that have been reached in the past.\u201d<\/p>\n","protected":false},"excerpt":{"rendered":"

Equities and real estate can structually deliver returns in excess of economic growth, but within limits, says Robeco investors Lukas Daalder.<\/p>\n","protected":false},"author":1,"featured_media":69950,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1480],"tags":[1809,1655,1659,1657,1651,2087,2068,2020],"_links":{"self":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/69952"}],"collection":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/comments?post=69952"}],"version-history":[{"count":0,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/69952\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media\/69950"}],"wp:attachment":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media?parent=69952"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/categories?post=69952"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/tags?post=69952"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}