Power of the PENsion: Two-Faced January – Looking Back to Look Ahead at Capital Markets


Looking Back to Look Ahead at Capital Markets

The month of January is named for the Roman god Janus, the god of thresholds and new beginnings. Janus is depicted with two heads signifying his look back to the past even as he looks forward to the future.

At Highland, it’s been our practice to analyze economic events of the past and trends we’ve observed to develop our capital markets expectations for the future. Pension plan sponsors, likewise, are reviewing market expectations as they consider revisions to their assumptions for pension plan funding in the new year.

The Face with the Mask

A look back to 2020, now four years ago, would have us recall the COVID-19 pandemic and the pandemonium that it ushered in. But even before the pandemic, in 2018 and 2019, the economy had experienced a wild ride. (Read our summary here.) In short, a global economic slowdown, disruptive trade wars and mixed messages from the Fed had unsteadied the market. In 2018, the Fed had raised rates four times, including a December 2018 hike. In 2019, they reversed that policy and lowered rates three times. A booming tech sector and the monetary easing by the Fed sent markets to all-time highs by the end of 2019.

Then came the pandemic and shutdowns. Yet despite these disruptions, the return assumptions for the basic 60/40 U.S. equities/long duration credit portfolio have not changed significantly in recent years. Our forecast for the end of 2020 was 4.7%, which has since increased to 5.9%, owing primarily to rising interest rates. Over time, our equity forecast for the U.S. has remained relatively stable.

 The Face of the Future

So then, what might we expect for 2024 in pension plan assumptions, funding, and required rates of return?

We know that investment consultants generally revise their capital market assumptions by incorporating recent experience into longer-term projections (a la Janus). Given the rise in interest rates and strong equity performance in 2023, it's not surprising that the fundamental building blocks of most pension plan portfolios have shifted accordingly. To wit,

  • Expected returns for large- and small-cap U.S. equities, emerging markets equities, and developed international equities have been lowered by 25 basis points.
  • Higher interest rates (experienced throughout most of 2023) lead to higher expected returns due to the strong correlation between starting yield and future returns. While Highland’s long-term credit forecast has increased by 25 basis points year on year, expectations for long-term government bond yields has increased significantly more, by 125 basis points.

Face the Future without Fear

For plan sponsors establishing 2024 return assumptions for pension plans, it's crucial to focus on data and to avoid emotional responses to volatility. Headlines and media reporting may overly dramatize impacts to the economy, risk assets, and interest rates. We at Highland encourage a more measured response. Stay true to your planning discipline and set assumptions on returns based on historical trends and reasonable forecasts. Overly optimistic or overly pessimistic assumptions are impediments to the best way to face the future—with confidence.

We’d love to have a conversation with you about your plan to help you gain the confidence you’re looking for. Call Mike Paolucci at 440-808-1500.

Highland Consulting Associates, Inc. was founded in 1993 with the conviction that companies and individuals could be better served with integrity, impartiality, and stewardship. Today, Highland is 100% owned by a team of owner-associates galvanized around this promise: As your Investor Advocates®, we are Client First. Every Opportunity. Every Interaction.

Highland Consulting Associates, Inc. is a registered investment adviser. Information presented is for educational purposes only and is not intended to make an offer of solicitation for the sale or purchase of specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.