Rob Arnott, founding chairman and head of Research Affiliates, discusses why the PIMCO All Asset and All Asset All Authority funds’ ambitious, inflation-based secondary return benchmarks still make sense; Omid Shakernia, senior vice president of asset allocation, provides insight into how Research Affiliates’ proprietary business cycle modeling is informing asset allocation decisions; and Chris Brightman, chief investment officer, discusses why emerging market valuations still look favorable despite the recent strong rally in EM stocks. As always, their insights are in the context of the PIMCO All Asset and All Asset All Authority funds.

Q: The PIMCO All Asset and All Asset All Authority funds have secondary benchmarks of Consumer Price Index (CPI) +5% and CPI +6.5%, respectively. Are these return aspirations still realistic?

Arnott: Before delving into our return outlook, let’s discuss how we view our CPI benchmarks. Admittedly, these secondary benchmarks are unusual and differ from more traditional index-based benchmarks. From a market peak, they are stretch goals, and tough to achieve; from a market trough, they should be far easier to achieve. Importantly, I’m referring to a peak or trough for Third Pillar assets (diversifying markets – real assets, emerging markets and high yield bonds), which are at the heart of the All Asset strategies, not for more conventional stocks! We’ve just finished the first year of a bull market in Third Pillar assets after a challenging three-year bear market. So, we’re closer to a trough than a peak. In short, I do not think these CPI-based benchmarks should be difficult to reach from current Third Pillar market valuation levels.

The same cannot be said for conventional U.S. stocks and bonds. U.S. stocks are entering the ninth year of a bull market and recently reached a Shiller P/E ratio of 29, a valuation level seen in only two other periods over the past 140 years: just before the stock market crash in 1929, and during the tech bubble from 1998–2001. That’s it.

Sadly, many U.S. pension funds – and investors’ IRA and 401(k) portfolios – are counting on earning about a 5% real return, over and above inflation, to meet their financial needs in retirement.1 In a world of meager bond and stock market yields, most mainstream programs will likely fall far short of this goal. We estimate that a 60/40 U.S. stock/bond portfolio (i.e., 60% S&P 500 Index and 40% Bloomberg Barclays U.S. Aggregate Bond Index) is currently priced to deliver CPI +0.9% (about 3% including inflation) and has less than a 1% chance of delivering CPI +5% in the coming decade.