Are pension plans making pipe-dream return forecasts?

A new study shows return expectations that are far above what’s supported by market realities

Are pension plans making pipe-dream return forecasts?
With stock valuations at all-time highs and many experts expecting an impending correction, one would assume sophisticated fund managers would be cautious with their return expectations. But a new study suggests that institutional funds may not be doing that.

A new study by Aleksandar Andonov of Erasmus University Rotterdam and Joshua Rauh of Stanford University looked at expected returns among more than 230 public pension plans with over US$2.8 trillion in combined assets. The average annual return the plans assumed for their portfolios — typically consisting of cash, US and international bonds and stocks, real estate, hedge funds, and private-equity or buyout funds — was 7.6% over the long term, reported the Wall Street Journal.

“They expect cash to return an average of 3.2% annually over the long run; bonds, 4.9%; such ‘real assets’ as commodities and real estate, 7.7%; hedge funds, 6.9%; publicly traded stocks, 8.7%; [and] private-equity funds, 10.3%,” the report said.

Given the 1.4% yield from three-month US Treasury bills, it noted, 3.2% return expectations for cash are unrealistic. While T-bills have returned an average of 4.8% annually over the past half-century, short-term interest rates would have to spike for cash to even approach that number.

Meanwhile, 10-year Treasurys are yielding 2.6%, while investment-grade corporate bonds are averaging less than 3.7%. “[I] t would take a near-miracle today to get anything close to 4% out of a high-quality fixed-income portfolio,” the Journal said.

And while US stocks achieved average returns of 10.2% annually over the past 90 years, stocks today are more expensive than they have been for most of that time. Citing finance blogger Jesse Livermore at, the article said stocks are unlikely to exceed an average of 5.9% annually over the long run from today’s inflated base.

Finally, the Journal said buyout-business veterans recognize that the private-equity market is “competitive and overvalued,” making it difficult for future returns to replicate those achieved before.

“But the new study of estimated returns finds that the older a pension fund’s holdings of private equity are, the more likely its officials are to extrapolate those returns — as if the good times of the early 2000s, when deals abounded and buyouts were cheaper, were still rolling,” it said.

Citing an unnamed chief investment officer of a large public pension plan, the Journal said pension plans have been forced to make grand projections to match the generous retirement benefits states guarantee for millions of current and former government workers.

Related stories:
How to temper clients' 'beat the market' fixations
The glass ceiling in alternative investments