NEW YORK and LONDON, Feb. 6, 2013 /PRNewswire/ -- Pension plans and other institutions are not expected to achieve their target returns of seven to eight percent over the next 10 years, according to the 10-Year Capital Market Return Assumptions report released this week by the BNY Mellon Investment Strategy and Solutions Group (ISSG) and BNY Mellon Wealth Management.
"Based on our research and analysis, we are projecting extremely low fixed income returns and single-digit equities returns over the period, which will make it challenging for institutions to reach their target returns," said Jeffrey Saef, managing director for BNY Mellon and head of ISSG. "If institutions remain intent on aiming for combined eight percent returns, they may need to seriously consider taking on more risk in their portfolios."
ISSG analysis derives an expected return of seven percent for US large cap stocks and similar risk-adjusted returns for US small and midcap stocks annually over the 10-year period. These returns are propelled by real earnings growth of two percent per year, a dividend yield of 2.25 percent and developed market inflation of 2.5 percent. ISSG noted that the two percent earnings growth projection is significantly below the near-term consensus of six percent annually.
In fixed income, ISSG sees real cash rates rising to approximately one percent annually in the US in 10 years. ISSG said with inflation at 2.5 percent, it expects the 10-year Treasury yield to be 3.5 percent, causing long-term Treasuries to provide a negative return over the 10-year period.Expected returns for alternatives depend heavily on the underlying asset class, with a range of three to over 11 percent for the category, ISSG said. The report notes that interest rate increases could adversely affect returns of fixed income assets held by pension plan sponsors, many of which are underfunded. However, these same interest rate increases would also reduce plan liabilities, which might result in a net increase in funding levels. ISSG said that concerned plan sponsors need to consider whether they need to add exposure to equities. In addition, they could consider shortening the duration of their fixed income holdings, the report said.