As 2024 draws to a close, financial markets are adjusting to a shifting macroeconomic environment. Inflation’s recent decline from its post-pandemic highs and the Federal Reserve’s subsequent pivot from restrictive to more accommodative monetary policy herald what could be an extended period of sustainable growth.
While this recalibration may take several quarters—if not years—to fully run its course, we see several reasons for providers of defined contribution (DC) plans to be optimistic about the current investment outlook.
Four key observations inform our view:
- A healthier economic backdrop supports returns: Sustained economic growth justifies currently elevated valuations across key market sectors and could help drive returns over an extended time horizon. For long-term investors, including most DC participants saving for retirement, this environment supports remaining fully invested and appropriately diversified. Target date funds provide an effective solution for maintaining a prudent level of risk as retirement approaches.
- Traditional fixed income regains strength: While we expect yield on defensive cash strategies to fade, investors may benefit from traditional bond investments’ income, capital appreciation and risk diversification. Fixed income can serve as “ballast” in DC participants’ retirement portfolios, smoothing performance during periods of market volatility.
- Higher volatility powers active management strategies: Elevated volatility, which tends to accompany a regime shift from rising to falling rates, will likely be supportive of active management in public markets. Passive investing will still play an important role in DC plan portfolios, but investors should not overlook efficient, low-cost active management, which can help enhance potential returns and mitigate risk.
- Falling rates lift real assets: Broadly, real assets have proven to be resilient to inflationary environments, improving the diversification and performance of portfolios across time. Specific categories like real estate can also benefit from a decline in interest rates. In a falling rate environment, diversifying beyond stocks and bonds may be increasingly attractive for multi-asset retirement solutions such as target date funds, risk-based funds and managed accounts.
Our base case: A favorable environment for diversified portfolios
J.P. Morgan Asset Management’s recently released 2025 Long-Term Capital Market Assumptions, which forecast asset class returns over a 10- to 15-year investment horizon, offer powerful insights into the macroeconomic environment that is likely to prevail over the next decade. For investors seeking to define a long-term investment strategy, these projections can help anchor return expectations amid the inevitable ebb and flow of market volatility.
The latest report asks a key question: Will a generally benign economic backdrop counterbalance the risks posed by elevated valuations across certain public market sectors, such as U.S. large cap stocks and investment grade corporate bonds? Broadly, we think the answer is yes. High levels of employment, investment and consumption should help support economic growth over the forecast horizon and are consistent with sustained corporate profitability and balance sheet health.
Exhibit 1 illustrates the range of long-term returns available across various combinations of bonds (represented by the Bloomberg U.S. Aggregate Bond Index) and stocks (represented by the MSCI All-Country World Index). Looking ahead, the 2025 stock-bond frontier is modestly lower than last year’s projection and has a somewhat shallower slope, indicating that the forecast for fixed income has seen a relatively smaller decline than our equity forecast.
Against this backdrop, we expect a broadly diversified portfolio invested in stocks and bonds may still deliver adequate returns with moderate risk. The commonly cited 60/40 stock-bond proxy portfolio return is 6.4% over our 10- to 15-year forecast horizon, down from last year’s projected return of 7.0%. The outlook for equities is somewhat constrained by high current valuations, but this effect is—to some extent—the result of a highly concentrated U.S. large cap market. Across other U.S. stock sectors, and global equity markets more broadly, valuations are less extreme.
We consider the 60/40 portfolio to be a useful proxy for the experience of DC plan participants invested in target funds. While participants may continue to be well served in a diversified strategy, the year-over-year decline in the long-term forecast increases the importance of identifying additional sources of incremental return.
Cash benefits fade while traditional bond strategies look better
Inflation will likely continue to fall toward central bank targets, although the time frame for this adjustment remains uncertain. This decline may allow additional monetary policy easing, which would reduce yields for cash or cash-like strategies over time. The expected return from holding cash over the investment forecast period is approximately 3%, despite initial cash yields of nearly 5%. Importantly, cash-like investments do not offer the prospect of capturing total returns through price appreciation.
Traditional bond strategies may provide superior potential performance given that they can appreciate as interest rates decline. Even in a scenario where longer interest rates decline only modestly relative to their initial starting point, the yield on longer bonds will likely exceed that of cash in due course, leading to better performance over the full forecast period. Finally, these core fixed income strategies invest in extremely high quality, liquid assets that offer resilience in changing business cycles and provide defensive performance characteristics, even in a market downturn.
Across public markets, active management may help drive investment performance
Passive investing is often seen as safer and less costly than active management, but that perspective is at best incomplete—and perhaps even mistaken. Passive benchmarks are no less likely to experience volatility, and a strategy’s true cost must take price (fees) as well as performance into account. Active management can help avoid the inefficiencies associated with many traditional benchmarks, including arbitrary market segmentation, incomplete market representation and potentially significant structural inefficiencies. At the same time, these strategies also allow skilled managers to seek excess potential return, which can help offset the impact of higher management fees.
Identifying skillful active managers, however, requires applying a disciplined analytical framework across a wide range of performance metrics, but there is ample evidence to suggest that successful managers can and do add value. Exhibit 2 shows that historical average manager performance is positive across many market segments, and top quartile managers deliver positive results across all segments. Offering high quality active strategies on a DC plan’s core menu, often alongside comparable passive strategies, is a sensible option that can give plan participants an appropriate level of investment flexibility.
Historically, DC target date funds have often defaulted to passive investments for reasons other than investment outcomes. Nevertheless, relative to the baseline of a fully passive approach, there are several ways to “step out” into active management: First, by employing active management in fixed income only (a “blended” approach); second, by also adding active equity (a “fully” active approach); and third, by extending into select alternative asset classes.
Incorporating real estate can improve target date fund returns
Although returns appear likely to trend lower across public markets over the forecast period, a handful of private market sectors may benefit materially from the pivot from higher to lower interest rates. While alternative asset classes often fall outside the scope of DC plans, it has been possible for some time to incorporate real estate into a target date fund without limiting transparency or liquidity.
Over the past 10 years, target date funds that incorporate direct real estate exposure have delivered slightly higher returns with lower volatility than those that do not (Exhibit 3). This performance advantage factors in the negative repricing of the real estate markets over the past two years. Going forward, those portfolios could see their return advantage potentially increase without experiencing any greater volatility—a potentially winning combination for long-term investors.
The strategic case for real estate as a long-term investment is well founded, but for plans considering adding it to a target date fund strategy, timing considerations may play a role. In this respect, the 2025 Long-Term Capital Market Assumptions indicate a potentially promising entry point: Right now, core real estate is projected to return 8.1% over the 10- to 15-year investment forecast horizon, but more specialized value-add real estate exposure offers the highest of all projected returns, at 10.1%.
Conclusion: Healthy foundations for future growth
Shifting market conditions present an opportunity to consider adjustments to DC plan investment menus. While it may be volatile at times, the macroeconomic environment will, we believe, remain broadly supportive of long-term returns across diversified portfolios of stocks and bonds over a 10- to 15-year investment horizon. The higher volatility associated with our forecast should be supportive of active management in public markets, and declining rates may improve return prospects for less widely used private markets, such as real estate.
DC plans have always sought to provide participants with a stable platform for building long-term wealth. More recently, plans have expanded their focus beyond capital accumulation to offer participants tools for managing the decumulation of capital in retirement, too. In either case, sponsors’ ability to make prudent adjustments to plan offerings over time is essential to helping participants reach their ultimate financial goals.