It is often said that Institutional Investors are less prone to build their future (ex ante) portfolio return expectations on past (ex-post) return realizations. Individuals, however, the narrative goes, are subject to “animal spirits” and extrapolate past performance to their forward-looking views. At the peak of an equity market boom, a mood of exuberance prevails, while at the bottom of a trough, the only possible (perceived) light in the tunnel could only be a rushing train. It is even suggested that “tactical” asset allocation could be motivated by rational institutions taking advantage of reeling individuals. In reality, return expectations by institutional investors might not either be that realistic. In a recent research paper, The Return Expectations of Institutional Investors (Feb. 2018), it is suggested that even institutional investors form their forward-looking expectations on past performance. Based on a cross-sectional study of 231 U.S. state and local government pension plans, the authors find that forward-looking return are correlated with realized returns over the past 10 years along with funding status. According to the study, their nominal average expected return is 7.6%, resulting in an expected real return of 4.8%. Future returns may not be as generous. Valuation levels should be the most important driver for long-term real returns. For a discussion of valuation and long-term returns, please see my blog
post “It’s the Valuation, Stupid”; https://www.franzenadvisory.com/blog/date/2018-01.