If only.(Image: Damon Moss/Thinkstock)

Lower returns over the next 10 years will requireadvisors to be more disciplined in theirportfolio strategies, according to Patrick Nolan, director andportfolio strategist of BlackRock Portfolio Solutions.

During a session at the Investment & Wealth Institute'sInvestment Advisor Forum in Midtown Manhattan, Nolan looked at thepast 10 years of returns in the United States and then forecastedwhat those returns may look like for the next 10 years. And hespoke about what effect this could have on portfolios.

Nolan looked at the S&P 500 and the Bloomberg Barclays USAggregate Bond Index for the past 10 years — from January 2009 toDecember 2018 — and determined a 60/40 stock/bond blend return of9.3%.

Meanwhile, BlackRock's 10-year capital market assumptionssuggest that a hypothetical 60/40 stock/bond blend would return5.5% for the next 10 years. This refers to 60% of a hypotheticalportfolio achieving the expected stock return of 7% and 40% of theportfolio achieving the expected bond return of 3.2% over the next10 years.

“We're looking at close to 400 basis points of less return perannum over the next decade versus the last decade,” Nolanexplained. “This to me represents a challenge. Think about thatclient that needs 6 [percent return]. We had an easy timedelivering it in the last 10 [years], we'll have a really hard timedelivering it in the next 10 [years].”

Nolan then discussed the portfolio attributes that advisors needto be successful in the next decade.

According to Nolan, investment success will require adisciplined process, low drag, and the ability to execute portfoliotilts with precision.

Ultimately Nolan thinks portfolios over the next 10 years aregoing to need to demonstrate these four characteristics in order tobe successful in this lower-return environment.

1. Reduce the drag on returns.

“As it relates to capturing what the market actually deliversus, we're going to need to reduce the drag on returns. If themarket's only going to give me 5.5% for this 60/40 blend, I need tocapture as much of that 5.5% as I can.”

Largely, sources of drag on returns are fees and taxes.

Based on 9,940 advisor model portfolios collected by BlackRockin the trailing 12 ended Sept. 30, 0.54% of returns were spent onmodel expenses, on average. The average annual return lost to taxeswas 1.18%. Also, 1% of returns was spent toward the typical advisorfee, according to Nolan.

2. Gain efficient exposure to the real drivers of excessreturn.

Advisors will need to figure out “ways to generate excessreturns if in fact my client's required returns are higher thanwhat this 5.5% projects,” Nolan said.

According to Nolan, low returns for 10 years will testinvestors' confidence, and excess returns will matter more in thisenvironment.

One way to do this is through factor products.

According to Nolan, factor product usage is broadening andbecoming more consistent.

Based on BlackRock's model portfolio analysis, 4% ofconservative portfolios were allocated to factor products, alongwith 10.6% of moderate portfolios and 16% of aggressiveportfolios.

3. Allocate more to assets with the highest expected returnassumptions.

“We're going to need to find ways to get clients morecomfortable with owning things they are less comfortable owningtoday,” Nolan explained.

In particular, Nolan meant addressing investors' home-countrybias.

“It's easy in this moment with the way U.S. markets have run tosay, 'why wouldn't I be overweight U.S., they've been doinggreat,'” he said.

According to BlackRock's capital market assumptions, theestimated annual returns over the next 5 years are 6.8% for U.S.large-cap stocks, 8.7% for European stocks and 9.4% for emergingmarket stocks.

4. Be deliberate when using active managers.

According to Nolan, there is crowding by active managers withina portfolio.

He adds that there are lots of great managers, but limited alphapotential. Nolan suggests advisors asking “What does the rightmanager look like?”

Advisors who execute with discipline in this more challengingenvironment will emerge in a stronger position, he concluded.READ MORE:

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