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Five-Year Market Outlook: How Slow Growth Transitions and Inflation Recalibration Impact Pension Plans

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  • On: 04/19/2023 12:44:51
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By: Bob Parise, Northern Trust Asset Management

With below-average returns expected over the next five years, getting asset allocation right will be paramount in maintaining funded status. We expect slower economic growth and higher interest rates to result in below-average five-year returns for most asset classes used by pension plans.
Five-Year Market Outlook: How Slow Growth Transitions and Inflation Recalibration Impact Pension Plans

This is an excerpt from NCPERS Spring 2023 issue of PERSist, originally published March 21, 2023.

With below-average returns expected over the next five years, getting asset allocation right will be paramount in maintaining funded status. We expect slower economic growth and higher interest rates to result in below-average five-year returns for most asset classes used by pension plans (Exhibit 1). Equity returns are challenged by a lower valuation ceiling and profit margin compression because of higher interest rates. Below-average returns would create hurdles for pension funds looking to build cost-efficient, lower-risk portfolios with adequate performance over the next five years.


Slow Growth Transitions
The shifts from pandemic to endemic, globalization regionalization and fossil fuels to renewable energy represent economic challenges for a global economy already facing high debt and changing demographics.


Key Considerations for Pension Plans
As slow economic transitions unfold over the next five years, market volatility and uncertainty will likely remain high, due to slower growth expectations. Various economic factors, including weakened economic growth and lingering supply chain issues, are new to investors and add to the potential for negative market surprises given this combination of market concerns is historically unprecedented, especially given the push towards economic globalization in recent decades. Lower volatility equities have historically demonstrated asymmetric returns, meaning they tend to capture more upside when equities gain than downside when equities fall, as shown in Exhibit 2. This has increased the chance of outperformance amid turbulent markets.


Inflation Recalibration
Post pandemic global supply chain complications and worker shortages left a bigger mark than expected on inflation. Still, many investors and policymakers believed inflation was “transitory” and would eventually revert to normal levels. This all changed with the war in Ukraine, which triggered soaring food and energy prices. The inflation genie escaped the bottle and putting the genie back will take some time. Still, we believe the worst has passed and we expect inflation to moderate gradually.
 
Key Considerations for Pension Plans
With likely elevated inflation for a while, plans need to reassess the risks inflation creates in their portfolios. Real assets can provide protection against unexpected inflation, while real estate and listed infrastructure offer additional risk exposures for portfolio diversification and higher yields than traditional equities.


Final Thought: Be Creative With Risk
We anticipate some deterioration in the challenging equity environment ahead with developed market corporate profit margins at historically high levels. Plans will need to be nimble and dynamic with their risk budgets in order to hit their short- and long-term return targets. Given slow growth and elevated inflation, plans can look to private markets or low volatility strategies to close the forecasted return gap from their equity allocations over the next five years.
 
To learn more about how to position your portfolio to achieve your plan's objectives over the next five years, contact Bob Parise.

Author Bio: Bob Parise is managing director, head of sales and relationship management, and practice lead for public funds and Taft-Hartley plans for the institutional client group at Northern Trust Asset Management. He is a member of the Business Leadership Council. Bob collaborates across sales and client relationship management to establish business strategy and lead the delivery of investment solutions in the equity, fixed income and alternative asset classes. Bob has more than 25 years of industry experience. He holds a bachelor's degree in business with an emphasis in finance from Western Illinois University and an MBA from DePaul University.
 
Disclosures
IMPORTANT INFORMATION
Northern Trust Asset Management is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Belvedere Advisors LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company. © 2022 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation.

For more information about disclosures, please view page 7 of the full paper.


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