The real 10-year expected return and risks do not look attractive. The real returns over the next ten years will vary between 1-3%. This can be compared with the expected return than many pensions are using which is closer to 7.5. If that is the case, pension will be further under-funded and will have be required to add more cash or find some other alternative investments to make up what could be a more than 500 bp shortfall. Think of what will be required of hedge funds to make up this shortfall. The expected return for alternatives is on the high-end of portfolio returns, so just finding the average manager will not be enough. Investors are going to have to find great managers who are uncorrelated with equities. The returns are need to pull up the return of the portfolio versus bonds. Diversification is necessary to allow investors to hold higher returning equities that are significantly riskier than the total portfolio.
These simple dynamics explain why a simple "LED" portfolio of liquidity, equity-based, and diversifying assets can go a long way for showing what is needed to help meet investor needs. Pension need to hold cash for immediate fund requirements, equity-like instruments for return, and diversifiers to ensure the portfolio does not have get too underfunded in "bad times". The hunt is on for finding those special asset that truly add portfolio value.
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