Monday, July 11, 2016

SSGA survey - why are investors optimists?

The latest SSGA survey has come out with the return expectations of institutional investors. The survey provides a good perspective of what investors are thinking about a number of investment issues including their views on future returns; nevertheless, I am surprised at the long-run returns expected by investors. They think equities will generate 10% returns and fixed income will come in at about 5.5%. In these elevated markets and with current global uncertainty, these investors are being optimistic. We can have that view by looking at the returns for the S&P 500 and 10-year bonds since 1928.

There is a greater than 50% chance of equities being above 10% in any one year and a greater than 60% chance of averaging above 10% in any five year period. Assuming a 10% average is not out the realm of possible. For bonds, there is only about a 1/3 chance that fixed income will be greater than 5.5%. This is not accounting for the fact that rate levels are extremely low. The carry on the 10-year bond is now below 1.5%. The fixed income view seems very optimistic.

The equity and bond expected returns are optimistic but could still be considered likely, but the overall portfolio returns are expected to reach 10.9%. Assuming a 60/40 stock/ bond mix and using the survey expectations for  each asset class, the expected portfolio return would be 8.2%. This means that through asset selection and dynamic portfolio adjustments, investors believe they can add 270 bps of alpha. Again this is possible but will require significant returns from alternative investments. The alternative portfolios will have to add both beta and alpha to help reach the overall expected goal of the portfolio.

Perhaps managers know something special, but these numbers look more like a extrapolation of the past than a careful judgement of the future. 

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