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‘No One Should Expect Returns of 5%’: Research Affiliates

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The numbers don’t lie, according to experts at Research Affiliates, and that means it’s time to scale back expectations when it comes to real returns in the coming decade.

“We’ve plotted it – there’s nothing above 5%,” said Chris Brightman, chief investment officer of Research Associates, at a symposium the group hosted in San Francisco on Wednesday. “And there’s really no combination of asset classes that will get us [even] to 5% real returns.”

And that means investment professionals need to have the tough talks with investors. “Have the conversations you need to with boards, trustees, clients and those you advise and suggest that their expectations have to be adjusted down,” Brightman explained.

Yes, we’ve had a boom in bonds for 30 years and strong gains for stocks. “But today – no one should expect returns of 5%, because we’re not starting from historic average yields [of 5% or higher]. It’s a simple approach.”

The “simple” the Research Affiliates expert is referring to involves a model of analysis that has factored in returns for the past 100 years. That data is then displayed in a classic scatter-plot graph, which looks at volatility and expected returns over the next 10 years.

“Yes, emerging-market equity has expected 7% real returns,” Brightman said. “But recognize, it comes at extraordinarily high volatility of 22%, meaning it can move 50% at times.”

The same goes for Russia. “There may be low prices today, but there’s off-the-chart risk and huge opportunities for volatility in returns.”

Shiller Stats

The Research Affiliates managing director describes the Yale economist Robert Shiller’s latest price-to-earnings (P/E) ratios.

Shiller, who introduced cyclical tweaks to historic asset analysis, says that with a U.S. equity ratio of 27, we should expect lower future returns ahead.

“It’s far above the average median of 16,” said Brightman. “And there are reasons for this, like low interest rates.”

But it’s worth exploring other markets (as Shiller has done recently), he says.

At 12, P/E ratios are not extended in the United Kingdom, a figure that is below the median, the expert states.

And watch out for what’s happening in Japan, he adds, where bond yields are expected to be in negative territory for the next 10 years. (U.S. bond yields will barely be above zero.)

“With a debt level of 250% of GDP, I see it as unsustainable. They are monetizing debt,” Brightman said. This means pension funds are selling bonds, while the Bank of Japan is buying them back to raise inflation.

“It’s a fascinating macroeconomic experiment,” he explained.

Japan, like the U.S., is coping with a rapidly aging society. In the United States, Brightman said, we’ve got lower growth in GDP as a result of the impact of baby boomers. “They are a huge headwind,” stated Brightman.

GDP growth levels of 2%-3%, as we’ve seen in the past and that were surpassed in the ’80s and ’90s growth, are not coming back anytime soon, he noted. 

(To further dig into expected returns for stocks and bonds worldwide, he says, review estimates on Research Affiliates’ new website).  

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