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 The Challenge of Declining Expected Returns 

An  early 2017 study from investment advisory firm Research Associates suggested that a balanced US portfolio (typically invested 60% in stocks and 40% in bonds) which had a long term average annual performance of 6.6% before inflation over the past 30 years, now has a “zero probability of achieving 5% or greater annualized real return”, on average, over the next 10 years. The firm also suggested 3% to be the new norm of  expected return from such a typical "balanced" portfolio. A study published by the McKinsey Global institute drew a similar conclusion in May 2016.


The reasons are well known:


  1. Throughout history, annual bond yields averaged between 4% and 8%. In the summer 2016, a third of all government bonds yielded less than 0% and another third less than 1%. Despite the small grind higher in yields  witnessed since then, there isn't much to expect from this asset class in terms of "expected return" from current levels.

  2. Looking at stock market valuation and while this does not empty the potential for further equity market gains over the near term, the current CAPE Shiller PE of the S&P500 stands at a level that has only been exceeded twice over the past hundred years (in 1929 and 2007). Traditionally, when stocks suffer, bond markets serve as shock absorbers. Depressed (and mostly inexistent) government bond yields  and artificially inflated non junk rated corporate bonds suggest they might only offer a temporary and somewhat illusionary shelter over the  next few years. In the worst case, they might constitute a  source of potential underperformance, all by themselves.

The new conundrum of higher life expectation  and lower expected returns from traditional asset classes pose  a challenge that will require a more engaging and innovative investment approach.

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