Global Strategy Outlook

Investment Policy in a Low Return World

Low return investment policy

How should investment policy be framed to adjust to the realities of a low yield landscape? Some investors may respond to low beta by moving further out the risk curve or by paying more attention to alpha. Many will increase allocations to alternatives, including illiquid assets. Others will adopt a more dynamic approach to asset allocation.

A recently released paper from State Street, below, surveyed 400 asset allocators to understand the approaches being taken. Significantly, they discovered that expectations of 5 year returns for a variety of asset classes are very bullish, and probably overly ambitious, with equities expected to return 10% per annum. For comparison, a more rigorously constructed estimation for medium-term equity returns is likely to suggest equity returns nearer to 4-8% (see for example this CFA article).

Below, we have summarised some of the best papers on investment policy and investment strategy in a low return world. The paper from State Street looks especially at smart beta approaches and objective-based investing. Other papers highlights different approaches:

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Lower growth for longer - how to bridge the performance gap? (SSGA, 2016)
Based on a survey of 400 large institutional investors, this study sought to understand investors' policy, their asset allocation objectives, and framework for measuring success. Given the likelihood of performance shortfalls in the present low-return environment, investors were also asked how they were planning to fill the gap between stated aims and realized performance.

Living in a low-return world - implications for pension funds (JP Morgan, 2015)
Michael Cembalest and Anthony Gould examine the impact that lower long-term economic growth will have on asset class returns, and the implications and solutions for pension funds. Cembalest investigates how long-term interest rates are affected by trends in global demographics, growth, and productivity, while Gould investigates key solutions and considerations to overcome the implications on pension portfolios of a low-return paradigm.

Neutral on Equities in a Tale of Two Lows (Pioneer, Apr 2016)
The authors believe there is an increasing likelihood of remaining in a low inflation, low growth scenario for the long term. How does this impact long-term equity market returns? Within this environment, the authors argue for a substantially neutral view on equities.

Generating Income in a Low Return World (Goldman Sachs, Nov 2015)
Conservative, income-oriented investors face a number of challenges in today's low return market. The more income-oriented and risk-averse an investor is, the more challenging these issues in the future may be. How can investors navigate this new environment?

Multi-Asset Themes: The Need to Address Multiple Scenarios (Pioneer, May 2016)
The current low inflation, low growth phase doesn't inspire much confidence amongst investors. The authors of this paper believe that in this environment, it is vitally important to focus on robust portfolio construction.

Back to the Future: A guide to finding fixed income returns (JP Morgan, May 2016)
The authors set out the macroeconomic and market context for today's low yield world. They also look in detail at Japan's long battle with low growth and low inflation to see if any lessons can be identified to help fixed income investors navigate today's markets.

Pension De-Risking in a Low-Rate Environment (Cambridge Associates, 2013)
This paper explains the flexibly constructed glide path solution that achieves two goals: generating superior returns and reducing surplus risk of a significant decline in funded status. This solution is implemented by reducing directional equity exposure and replacing it with strategies that are driven by alpha and “non-traditional betas”.

Understanding and measuring the illiquidity risk premium (Willis Towers Watson)
​Illiquidity risk is a potentially appealing means of generating additional yields in a low-return world. The authors of this 10-page document discuss three different dimensions of illiquidity risk premium that investors should demand for a given asset.

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