In this, our second installment focused on tidbits from an analysis of Colorado PERA data by the Pension Integrity Project at the Reason Foundation , we’ll look at how experts view the likely rates of return of certain asset classes over the next 30 years, compared to the past 30 years.
For pension funds like PERA, hoping that strong future returns will help address at least some of their massive unfunded liabilities, it’s not a pretty picture.
Using projections from the McKinsey Global Institute, Reason sees little cause for optimism.
“The “new normal” for institutional investing suggests that achieving even a 6 percent average rate of return is optimistic,”according to Reason’s analysis. Bear in mind that PERA last year lowered its projected rate of return from 7.5 percent to 7.25.
Here are reasons not to bank on robust rates of return, according to the analysis:
- Over the past two decades there has been a steady change in the nature of institutional investment returns. 30-year Treasury yields have fallen from around 8 percent in the 1990s to consistently less than 3 percent today. Globally, interest rates are at ultra-low historic levels, while market liquidity continues to be restrained by financial regulations.
- McKinsey & Co. forecast the returns to equities will be 20 percent to 50 percent lower over the next two decades compared to the previous three decades. Using their forecast model, the best case scenario for a 60/40 portfolio of equities and bonds is likely to earn less than a 5 percent return.
- As PERA waits for the “recovery” its unfunded liabilities continue to grow.
On that final point, Reason points out, even as markets have recovered since the Great Recession, PERA funded ratio has continued to head south. In 1995 PERA’s funded ration stood at 89.8 percent, and the S&P 500 Index was at 541. By the end of 2016, PERA’s funded ration had plunged to 58.1 percent. Yet the S&P 500 had soared to 2,095.
Over the past 30 years, U.S. equities posted average annual returns of 7.9 percent. McKinsey projects that over the next 30 years, returns will fall somewhere between 4 and 6.5 percent.
The picture isn’t much different elsewhere. European equities also returned 7.9 percent on average over the past 30 years, but will return only 4.5 percent to 6 percent in the next 30 years. And both U.S. and European bonds exceeded 5 percent returns over the past 30 years, but are likely to fall far short of the over the next three decades — somewhere between 0 and 2 percent.
What does this all mean for the probability of PERA achieving its projected 7.25 percent over the next 10 years? Stay tuned for our next installment.