Defined Benefit
Insurance Assets
Nonprofit

Risky Business Update: Investors Face Additional Challenges amid Increased Uncertainty

Risky Business Update: Investors Face Additional Challenges amid Increased Uncertainty
clock
2 min 45 sec

Five years ago, Callan published “Risky Business,” a paper that focused on the challenges faced by institutional investors in the low return environment they found themselves in. The paper received a lot of attention, including from The Wall Street Journal, largely due to the graphic illustrating what was required in terms of asset allocation to earn a 7.5% expected return over various time periods. Our analysis found that investors in 2015 needed to take on three times as much risk as they did 20 years before to earn the same return.

Given that attention and the interest in our work from the institutional investing community, we wanted to once again update our analysis to reflect current conditions and to extend the comparison over a longer time period.

It is no exaggeration to say that 2020 turned out to be a truly historic year due to the rapid spread of COVID-19, which affected individuals and economies across the globe. Central banks around the world moved to zero interest rate policies and implemented massive monetary accommodation, while governments stepped in with unprecedented fiscal stimulus and support for businesses and workers.

In light of historically low interest rates, Callan made nearly revolutionary adjustments to our 2021 Capital Markets Assumptions. We lowered our fixed income return projection, and we also reduced our equity return assumptions to reflect concerns about valuations. Coupled with uncertainty around the strength and timing of a post-pandemic recovery, institutional investors face one of the most difficult investing environments in decades.

To find out how difficult, our experts examined what would it take for an investor to achieve a nominal 7% expected return over the next 10 years. Using our proprietary Capital Markets Assumptions, we found that investors in 2021 needed to take on almost 16 times as much risk as they did 30 years ago.

Return-seeking portfolios are now more complex and expensive than ever. Whereas in 1991 a portfolio made up of 98% cash (cash!) and 2% bonds was projected to return 7%, by 2021 an investor would need to include 97% in return-seeking assets (stocks and private markets) to achieve comparable return expectations.

30 Year Change in Risk to Achieve Same Nominal Return

To be sure, the early ‘90s were a different time, with not only higher fixed income yields but also higher inflation. Therefore, we examined what it would take to earn a 5% real return given our prevailing inflation expectations at the time. The graphic below shows that the pattern of increasing complexity over time remains similar over the 30-year period, although the level of additional risk is lower. Today investors need to take on roughly 2½ times the volatility as they did 30 years ago to earn a 5% real expected return, versus almost 16 times the risk when matching nominal return expectations.

30 Year Change in Risk to Achieve Same Real Return

While investors are cautiously optimistic that we’ve weathered the worst of the pandemic’s impact on the markets as vaccine rollouts begin, uncertainty surrounding what lies ahead and the impact on portfolios is on the minds of many. Whether assessed in a nominal or real framework, our conclusions from our 2016 study remain unchanged: Investors require far more complex and risky portfolios to meet their return targets. Clients must assess based on their specific circumstances whether such “risking up” and increased complexity is appropriate.

Posted by

Share
Share on facebook
Share on twitter
Share on linkedin
Related Posts
Public Markets

Stellar Markets Across Asset Classes

Kyle Fekete
Callan expert assesses the global markets in 3Q24 and the outlook heading into the election.
Private Markets

2024 Private Equity Fees and Terms Study: Lessons for Institutional Investors

Ashley Kahn
This study analyzes private equity fees and terms to help institutional investors.
Private Markets

Nonprofits: Same Mission, but New Approach to Allocations

Tony Lissuzzo
Callan expert discusses changes in nonprofit allocation trends over the last 20 years.
Private Markets

Private Real Estate Income Is Positive, but Appreciation Falls

Munir Iman
Callan experts analyze commercial real estate and REITs in 2Q24.
Private Markets

Gains Outpace Leveraged Loans Over Time; Spreads Contract

Constantine Braswell
Callan experts analyzes private credit activity in 2Q24.
Private Markets

Some Early Signs of a Rebound, but Challenges Remain

Ashley Kahn
Callan expert analyzes private equity activity in 2Q24, from fundraising to exits.
Public Markets

Gains for Stocks Mask Wide Disparities; Little to No Change for Bonds

Kristin Bradbury
Callan expert analyzes the global stock and bond markets in 2Q24.
Operations

A Deeper Look at How We Did With Our Capital Markets Assumptions

Julia Moriarty
An analysis of how Callan's Capital Markets Assumptions performed over time by asset class.
Private Markets

Significant Drops in Private Equity Activity From Peak Years of 2021-22

Ashley Kahn
Callan expert analyzes private equity activity in 1Q24, from fundraising to exits.
Private Markets

Sector-Specialist Strategies: What Institutional Investors Need to Know

Chrissy Mehnert
A look at sector-specialist strategies and how institutional investors can analyze them.

Callan Family Office

You are now leaving Callan LLC’s website and going to Callan Family Office’s website. Callan Family Office is not affiliated with Callan LLC.  Callan LLC has licensed the Callan® trademark to Callan Family Office for use in providing investment advisory services to ultra-high net worth clients, family foundations, and endowments. Callan Family Office and Callan LLC are independent, unaffiliated investment advisory firms separately registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940.

Callan LLC is not responsible for the services and content on Callan Family Office’s website. Inclusion of this link does not constitute or imply an endorsement, sponsorship, or recommendation by Callan LLC of their website, or its contents, and Callan LLC is not responsible or liable for your use of it. When visiting their website, you are subject to Callan Family Office’s terms of use and privacy policies.