Steering defined contribution plans through a complex world in transition

Explore what J.P. Morgan’s most recent Long-Term Capital Market Assumptions mean for defined contribution plans

Global financial markets are in transition, exiting a long period dominated by low inflation, easy monetary policy and low interest rates and entering a period characterized by higher inflation, more assertive fiscal policy and higher rates. For some market sectors, the adjustment has been rapid and may be nearly complete; for others the process is ongoing. Regardless, the significance of this shift warrants a careful review of investment strategy and plan design. 

Plan sponsors of defined contribution (DC) plans will need to adapt to this changing environment. We see real opportunities—and risks—for plan participants who are still in the saving and wealth accumulation phase of their working lives, as well as for retirees who have entered the spending phase. Balancing the key objectives of capital appreciation, prudent risk and stable income requires an evolving approach to the provision of target date strategies and broader menus of core and white-label investment options.

Three key points drive our discussion:

  • Broadly, the market environment is positive for investors whether they are seeking long-term capital appreciation or near-term income.
  • Across public markets, the need for thoughtful active management—as a potential source of return and as a mechanism for reducing risk—is as great as it has ever been.
  • The bond market’s move to higher yields represents a generational opportunity for retirees to obtain stable income.

Capital appreciation remains our base case

J.P. Morgan Asset Management’s recently released 2024 Long-Term Capital Market Assumptions (LTCMA), which forecasts asset class returns over a 10- to 15-year horizon, offers powerful insights into the investment environment that is likely to prevail over the next decade. The general outlook is broadly positive, with global growth strengthening slightly and global inflation declining from current levels to a projected 2.9% over the LTCMA horizon.

Against this backdrop, we expect diversified portfolios to deliver returns that are consistent with historical norms. Our widely used 60/40 stock-bond proxy portfolio produces an assumed return of 7.0% over the forecast horizon. While not as high as last year’s return assumption of 7.2%, this level is consistent with meaningful capital appreciation for long-term investors.   

Across key component asset classes, our return expectations for most equity sectors are slightly lower relative to a year ago, based largely on higher current valuations. For example, U.S. large capitalization equity return expectations fell from 7.9% last year to 7.0% this year. On a more positive note, however, non-U.S. developed market equity return expectations remained higher due to lower current valuations and a projected decline in the value of the dollar over our forecast horizon. In the eurozone, by way of illustration, we expect equities to deliver a long-term return of 9.7% in USD (down from 10.5% last year).

In fixed income, we expect 10-year U.S. Treasuries to deliver 4.6% (up from 4.0% last year) and U.S. aggregate bonds to provide 5.1% (up from 4.6%). The broad picture is one in which modest changes to portfolio composition can keep investors on track to meet long-term objectives.

For target date funds, the broad conclusion is similar: Making use of the spectrum of available asset classes will allow a judiciously constructed allocation to deliver targeted levels of risk and return at each stage of the savings-to-spending retirement glide path (Exhibit 1). Although the magnitude of year-over-year changes is modest, managers who have room to be flexible about the weights given to individual components should consider exercising their freedom. For instance, today’s higher interest rate environment may incentivize a gentle tilt toward fixed income, particularly in middle and later plan vintages.

Controlling risk with active management

Across public markets, the need for effective active management has never been greater—not only as a potential source of investment return but also as a mechanism for reducing risk across portfolios. 

The U.S. equity markets have become increasingly concentrated by sector and number of companies (Exhibit 2). Although this concentration results from individual firms’ strong performance, it can leave investors with a less diversified, riskier market exposure—assuming they invest passively. An active manager, however, can often find investments that offer similar or better fundamentals at a lower price.

In the bond market, investors deploy active management far more widely, and it has delivered consistent excess returns across time. At present, the rewards from active management may be even greater than normal given the possibility that higher-for-longer rates could still trigger a U.S. recession and credit downturn. For plan participants, the implications could be significant, because passive fixed income benchmarks do not incorporate a collective view on the quality or value of the underlying bonds—just the opposite. Passive bond strategies allocate capital according to each issuer’s total outstanding debt. 

This feature may have prompted only modest concerns when rates were low and capital was widely available at minimal cost, but with rates higher—and an increasing amount of corporate debt awaiting refinancing—the risks of using passive fixed income are more significant than ever. It would be unfortunate if today’s retirees, enticed by higher yields to own more bonds, found themselves exposed to capital losses from potentially avoidable downgrades and defaults.

Retirement income is now a reality   

In retirement, participants’ primary investment objective shifts from the accumulation of capital to supporting a prudent level of spending. For many years, low interest rates presented a challenge to meeting this objective, but the market’s recent move to higher bond yields is now offering a generational opportunity to obtain stable income. Plan sponsors should adopt a careful approach and lay out multiple pathways to delivering retirement income.    

The breadth and diversification of the bond market ensures that there will always be meaningful variations across individual sectors (Exhibit 3). To capture these opportunities, broad-based, actively managed strategies may prove especially effective.

Plan sponsors can take advantage of several approaches to deliver stable income options for DC plan participants. In Exhibit 4, we highlight some of the current pathways.

Navigating a changed world

Investors should take comfort in knowing that long-term equity returns are likely to deliver adequate levels of capital appreciation to meet savers’ needs. Higher interest rates present a unique opportunity to deliver retirement income using traditional fixed income strategies. And across all market sectors, active management is likely to provide a valuable source of return and risk management relative to passive strategies. 

As investors navigate global financial markets during a period of significant transition, thoughtful top-down plan design and skilled bottom-up active management are more critical than ever. Stability may be the goal of most DC plan designs, but even these investment vehicles can benefit from careful adjustments when market conditions change.