‘A massive system-wide problem, not just for those in finance, but more importantly for society at large’

Investors have been having a great time of it the last 30 years, benefiting from higher than average returns and lower than average volatility in the equity and bond markets.

But these positive conditions aren’t necessarily going to last, and investors should be prepared to rethink their strategies, according to a research note released by the Global Quantitative Strategy Team at AllianceBernstein on Tuesday, January 10.

“We are not bearish, but we suggest that the scale of the problem that this poses for society sets the principal challenge for professional investors over the next decade,” the note said.

Higher than normal returns

Equities and bonds have both experienced higher than normal returns since the early 80’s due to “extraordinary” conditions of low equity multiples and high bond yields at the start of that period, according to the note. Global equities have returned an average of 9.9% annually since January 1980 and investors in US equities have achieved 11.4% annually. Investors in US government bonds have also received a high rate of return of 8.2% annually over the same time.

That multi-decade bull market is set to end, however, according to the note.

According to the team led by Inigo Fraser-Jenkins,

“The return outlook for equities and bonds will be lower over the next 5-10 years than it has been over the last 30. In making this statement we are not precluding the possibility of large positive or negative returns from either asset class on tactical horizons of 2-3 years as the economic cycle evolves. Instead, what we are referring to is the structural background level of return that we should expect regardless of one’s views on the economic cycle.”

A huge impact on investors

Diminished returns would have a huge impact on investors.

According to the note (emphasis ours):

“The attractiveness of a 60:40 combination of equities and bonds has been unusually high in the last three decades. We forecast that this will not persist. For asset owners who have liabilities set in absolute terms or relative to inflation this will come to be a massive problem. It will be up to asset managers to propose solutions to this. Given the importance of this in funding savings for society overall, we suggest that this is the principle challenge that investors face over the next decade.”

“We think that this presents a massive system-wide problem, not just for those in finance, but more importantly for society at large that requires return and diversification, or risk mitigation, for savings,” according to the note. “Thus we suggest that this is the principal challenge that those of us in the industry face.”

The team led by Fraser-Jenkins are not the only ones to call for a change in investor expectations and strategy.

Blackstone Group’s investing guru Byron Wien called it last July when he said that the future nominal returns from public equities were more likely to be closer to 5% than 10%. “Almost all the investors I talked with felt their total return targets were too high,” said Wien. “But they were having difficulty convincing their superiors to lower them to more realistic levels.”