Friday, January 16, 2015

Who is Larry Doby?

In a departure from my normal investment-related posts, I am asking today, "Who is Larry Doby"?

I am willing to guess that at least 90% of the readers of this blog have no idea who the man is (pronounced "dough - be").  On the other hand, I am also willing to bet that nearly all of the readers of this blog know the name Jackie Robinson.

I first became aware of Larry Doby about 24 years ago while attending a dinner held in his honor in New York City.  You might ask why I would attend the dinner of a person I hadn't known prior to the invitation - but that will become evident as I write.  Once I learned about the man and what he had accomplished, I was more than a bit perplexed that I did not know of him - and I guess there is a lesson in that.

In life, Larry Doby was the second African-American to play Major League baseball. The first, of course, was Jackie Robinson.  Mr. Doby followed Jackie Robinson by only 10 weeks, debuting with the Cleveland Indians on July 5th, 1947.

While all due credit is given to Jackie Robinson for breaking the color barrier in American sports, Larry Doby never seems to be mentioned in this regard, yet we know he suffered with and endured the same trials as Mr. Robinson.  Had Mr. Doby a short-lived career, or one that was unremarkable, the lack of recognition might be understandable.  However, Larry Doby went on to have a career that spanned 13-years and included seven All Star appearances (Jackie Robinson was an All Star six times).

In fact, the careers of the two men were very similar.  While Jackie Robinson had a higher career batting average (.311 versus .283) and was a better base runner, Larry Doby had more home runs (253 to 137), RBI's (970 to 734) and a higher slugging percentage (.490 to .474).  

Jackie Robinson was deservedly elected to the Baseball Hall of Fame by the Baseball Writers of America in 1962.  He was named on over 77% of their ballots.  Larry Doby, however, failed to be elected by the BBWAA, never appearing on more than 3.4% of their ballots. Two men, playing the same game at the same time, both achieving success, but with two different legacies.

Now, let me ask a second question.  Who was the second African American to coach in the Majors? The answer, is the same as to my first question, Larry Doby (baseball fans will know that Frank Robinson was the first).

So, being second in America is sometimes almost the same as never having been there.  With our incessant focus on the headlines, the details often get overlooked. While we love to celebrate our heroes, we often neglect to celebrate men and women who are equally "heroic".

So whether it is Monday's Martin Luther King Jr holiday, or tonight's release of the movie "American Sniper" (which celebrates the heroics of US Navy Seal Chris Kyle), let us also consider those whose names we don't know -- because like Larry Doby, they too are heroes and truly deserve our respect.

Post scripts:

Larry Doby did have a few firsts.  He was the FIRST African American to hit a home run in the World Series, and along with Satchel Page, the first African American to win a World Series championship.

And finally, in 1998, Mr. Doby received deserved recognition when the Veterans committee voted him into the Baseball Hall of Fame.

Monday, January 12, 2015

Private Equity: Past, Present and Future

Source: Bain & Company

The Private Equity industry has grown and morphed over the nearly seven decades of its formal existence.  From primarily Venture Capital-related funds at the outset, to Buyout strategies (and a levered sub-segment); Secondaries; Fund of Funds; Distressed, Infrastructure; and Real Estate, private equity has typically taken on the dynamics of the macro environment around it, reacting to interest rate levels, spreads and the tax code to take advantage of conditions as they have presented themselves.  In this note, we will look at the development of the industry and its major sub-segments over time and also provide our insight as to what we think the years ahead might look like.


The current view of what constitutes the private equity industry today most likely began to take shape in the late 1940’s when organized, professional management firms with the sole purpose of funding private companies were established.  However, for decades before this, private market transactions were not at all uncommon.

The first major U.S. transaction was the notable buyout of the Carnegie Steel Company in 1901 by J.P. Morgan & Company for $480 million.  After the deal closed, J.P. Morgan famously quoted, “Congratulations Mr. Carnegie, you are the richest man in the world”, a fact of which Andrew Carnegie was supposedly embarrassed.  At the time, the $480 million transaction value equated to over 2% of US GDP.  Today, a similarly sized transaction would have to weigh in at nearly $355 billion.

Private acquisition activity continued apace until the early 1930’s when the Glass Steagal Act (technically the Banking Act of 1933) forced a separation of the activities of commercial and investment banks and hampered the further development of the US merchant banking industry.  The act essentially left private acquisition activity as the preserve of wealthy individuals and families.

After World War II, what are widely considered the first two modern venture capital firms were formed.  In 1946, American Research and Development Corporation was founded by Georges Doriot with the goal of encouraging investment in businesses run by returning soldiers.  In the same year, J.H. Whitney & Company was founded by John Hay “Jock” Whitney to provide capital and services to small and mid-market growth companies.  Based in New Canaan, CT, J.H. Whitney & Company is still in business today.

In 1958, the Small Business Investment Act was passed which aided in the financing and management of smaller enterprises.  Specifically, this act provided certain firms access to federal funds which could be levered at a rate of 4:1 against privately raised investment monies.  Though helpful, the industry still remained on the fringes of most investors’ radar.

Beginning in the 1960’s and continuing through the 70’s, the foundation upon which today’s industry is based was laid.  In the 1960’s private equity activity was predominantly centered around venture capital firms who focused on providing funding to start and expand companies, many of whom were in technology-related fields.  It was also during this period that the current Limited Partnership structure for private equity funds was introduced: 

  • Limited Partners putting up the money
  • General Partners identifying and acquiring investments and running the day-to-day business
  • A compensation structure comprised of a management fee plus a percentage of the profits

In 1973, the National Venture Capital Association was founded to serve as the industry’s trade group.  However, the stock market crash of the time quickly put a damper on fund raising and it wasn’t until 1978 that asset gathering normalized.

Buyouts are now the largest segment within the private equity world, with the leveraged sub-segment often commanding much of the attention.  The first generally acknowledged leveraged buyouts were the acquisitions of Pan-Atlantic Steamship Company and Waterman Steamship Corporation in 1955 by McLean Industries.  McLean borrowed $42 million and raised $7 million through the issuance of preferred stock.  Upon closure of the deal, McLean used $20 million of the target’s cash and assets to retire some of the borrowings.  This deal became a blueprint for many of the leveraged buyouts of the 1980’s and later.

 In the mid-1960’s, Henry Kravis, Jerome Kohlberg and George Roberts, then employees of Bear Stearns, began targeting the acquisition of family businesses that were facing succession issues.  These companies were generally too small to take public and their founders did not care to sell out to competitors.  It wasn’t until 1976 that Kohlberg, Kravis and Roberts left Bear Stearns to form what we know today as KKR.  About the same time (1974), Thomas H. Lee founded a new investment firm bearing his name to focus on acquiring more mature companies in leveraged buyouts.  Both firms have gone on to great successes.

The passage of the Employee Retirement Income Security Act of 1974 (ERISA) initially stunted industry growth as corporate pension funds were prohibited from owning what were deemed to be “risky” investments in private companies.  Largely as a result, industry-wide fund raising fell to $10 million in 1975.  In 1978, restrictions were relaxed and fund raising climbed quickly from $39 million in 1977 to $570 million, solidifying private equity as an important asset class with a significant following.  Other regulatory events late in the decade also supported the growth of the industry, most notably the capital gains tax rate reductions of 1979 (39.875% to 28%) and 1981 (28% to 20%). 

Boom and Bust Cycles – a more recent history

The Stars Align.  The First Big Boom (1982 – 1990)

Along with the capital gains rate tax changes, 1981 saw the peaking of interest rates.  Further fuel was thrown on the fire by investment bank Drexel Burnham Lambert, which essentially created the Junk bond market, allowing many middle market firms to borrow while bypassing the banks.  The issuance of high yield debt climbed from $1.5 billion in 1982 to $15 billion in 1984 and was almost entirely underwritten by Drexel.  Bank lending as a percentage of corporate credit fell from just under 60% at the beginning of the decade, to 15% by its end.  Further spurring the growth of leveraged buyouts was the Tax Reform Act of 1986 which provided strong incentives for corporations to substitute debt for equity financing (the curtailment of non-debt tax shields such as the investment tax credit and depreciation allowances were two such incentives).  And, as if this weren’t enough, the stock market soared.  Accordingly, the levered portion of the private equity industry boomed with commitments climbing nearly 10-fold from $2.4 billion in 1980 to $21.9 billion in 1989.  In total, it is estimated that more than 2,000 levered deals with a value in excess of $250 million were consummated.  As volume increased, new, niche areas also began to develop a following including secondary market purchases and industry-specific funds.

The venture segment saw numerous new firms enter the market, though capital managed by them grew only slightly as this area was not buffeted as greatly by the favorable events in the debt markets.  Instead, the segment gradually went through a shakeout with the best models rising to the top.

It should also be noted that this decade coincided with the arrival of the “corporate raider” that used many of the same financing structures as private equity firms, but typically acted as hostile investors in public companies.  Michael Milken’s bankers at Drexel Burnham supported many of these hostile investors through the funding of blind pools which enabled the transactions.  Levered private equity funds were often lumped in with the raiders – at least in the public’s eye.

At the time, public companies being taken private accounted for about ½ of all transaction value and large mature industries, like retail and manufacturing, made up the bulk of transactions. Subsequent to the junk bond collapse, these public to private deals fell to less than 10% of total value and middle market buyouts of non-publicly traded firms accounted for the bulk of deals (the public to private relationship currently stands at a more normalized level of approximately 46% of deal value).

The LBO Bust (1990 – 1992)

As with any boom, excesses appeared and a number of buyouts fell into bankruptcy, including those of the Campeau Corporation.  Campeau was a Canadian Real Estate company which acquired Allied and Federated department stores in the US in the late 1980’s and was one of the first, large levered bankruptcies of the decade.  By 1991, 26 of the 83 large deals completed between 1985 and 1989 had defaulted with 18 entering Chapter 11 bankruptcy proceedings.  LBO volume dropped by over 90% to under $10 billion.  At the same time, Drexel Burnham Lambert was tainted by the charge of insider trading against one of its managing directors, Dennis Levine.  Levine pled guilty and in turn implicated one of his partners, Ivan Boesky.  Boesky in turn, agreed to cooperate with the SEC regarding his dealings with Michael Milken.  The SEC initiated an investigation of the firm which dragged on for more than two years with Drexel finally pleading “no contest” to six felonies and agreeing to pay a fine of $650 million.  During this time, junk bond activity slowed dramatically and funding declined. 

Venture Capital and Technology.  The Second Boom (1993 – 2000)

Source: National Venture Capital Association

Source: Bain & Company

During the second boom, both venture capital and levered investments experienced a re-birth, with the former leading the way.  Private equity commitments overall climbed from roughly $20 billion in 1992 to $240 billion in 2000.  Venture commitments climbed from less than $5 billion to over $100 billion.  The overall industry also managed to separate itself from the taint associated with the 1980’s corporate raiders by emphasizing the growth and development of acquired companies to the point where such investors were often welcomed by managements (investments in capital expenditures and management incentives became more common place during this time).  Risk was moderated as less leverage was employed in the buyout sector (from 85% - 90% of purchase price in the 1980’s to 20% to 40% in the 1990’s).  Driving much of the deal activity was the new found interest in the internet, which drove a frenzy in start-ups and in some cases created new riches overnight. The vast majority of venture deals were completed in the Technology Software and Services space, setting the stage for the subsequent bust.

 Source: National Venture Capital Association

What Goes Up, Must Come Down.  The Internet Bubble Bursts (2000 – 2003)

As a large percentage of the “” investments were premised solely on the unlimited potential of the internet rather than a solid business model, many ran into cash flow issues and the dominoes were set in motion, leading to a large number of write-offs across technology and telecom-related investments.  By mid-2003, private equity fund raising was at less than half the peak level.  Leveraged buyout firms collapsed with a number of high profile shake-outs including Hick Muse Tate & Furst and Forstmann Little & Company.

The bust ended up forcing a greater level of due diligence upon investors and resulted in more controls being placed on investment partnerships.  Bank loans again became a more prevalent form of deal financing.

Driven by surging primary market volumes and regulations that increased capital set asides, many banks and insurers made strategic decisions to exit from in-house private equity operations.  Secondary market transactions (where one fund buys the private investments of another) grew from under 3% of commitments to over 5% of the total, joining venture and buyouts as a viable segment in the private equity world.

Thank You Messrs. Greenspan and Bernanke.  The Third Boom (2003 – 2008)

In the aftermath of the internet bust, seeds were also planted for the industry’s revival.  Lower policy rates and a relaxation of lending standards set the stage for some of the largest private equity transactions to date.  Unlike the boom of the late 1980’s which was fueled by the junk bond market, this boom benefited from the growth of syndicated bank debt – more than 50% of the LBO’s funded in 2006 were funded by bank loans.  The syndication process itself resulted in market imbalances which then contributed to the subsequent bust.  First, as the loans did not remain on the originating bank’s books, there was the likelihood that the diligence conducted in making the loans was relaxed.  Second, a number of the deals were funded with debt that had weak covenants (“cov-lite”).  Further, regulatory changes (the imposition of Sarbanes Oxley), helped the buyout industry convince public companies that life as a private firm might be preferable while the same legislation hurt the IPO dreams of many venture firms.  As a result, more of the venture deals ended up being done with strategic buyers (a purchaser in the same industry as the company) and secondary volumes grew, comprising over 20% of total transaction value.  The “Greenspan Put”, as it came to be known, convinced industry players and investors that the environment would not change and overall risk taking appetite increased.  Funding volume hit a peak of just under $700 billion in both 2007 & 2008.

Source: Bain & Company

A Different Kind of Exit

Toward the end of the third boom, an exit of sorts was seen by some of the larger private equity firms, though not in the usual context of selling portfolio firms.  In 2007 the Blackstone group filed for an IPO with the SEC and proceeded with a sale to the public (12.3% stake).  In the same year, the Carlyle Group also sold an interest in the management company (7.5% interest).  In January of 2008, Silver Lake Partners followed suit with a 9.9% sale of its management company to CalPERS.  To the cynical, this might seem like a backdoor way to raise liquidity for partners at a time when the size of their investments limited strategic sales and when the weakening market environment limited the IPO door.  It was promoted by the sellers as a way to spread the riches of private equity to a wider audience of investors. 

Yet Another Bubble Bursts

Low interest rates, no-money down mortgages and new residential mortgage financing vehicles led to an unprecedented run in the US housing market from the early part of the decade and into 2007.  As this bubble inevitably burst, its repercussions were felt world-wide.  From the failure of a Bear Stearns hedge fund during the summer of 2007 to the failure of Lehman Brothers a year later, the credit markets froze and spreads widened to record levels.  Globally, stock markets fell by more than 40% and as might be expected, the leveraged finance markets came to a standstill, with deal activity troughing at $134 billion in 2008.  Only the Distressed and Turnaround funds saw notable increases in fund raising in 2007 and 2008.

 Source: Probitas Partners

A Slow and Steady Recovery

It wasn’t until after more than a year of unprecedented intervention by US and other western central banks that confidence was secured and funding activity picked up.  From a trough of $296 billion in 2010, funding rose slowly to reach $461 billion in 2013 (2014 activity through August is on a similar pace).

Source: Bain & Company

The Present

The private equity industry is led by buyout strategies which comprised 37% of the capital raised last year.  Tangible asset strategies (Real Estate, Infrastructure and Natural Resources) made up an additional 31% of the total, while distressed, venture capital and other strategies comprised the remaining commitments.

Source: Preqin Global Private Equity Report 2014

The Future

While nothing is ever certain, the history of private equity has shown how the industry attempts to take advantage of (or is effected by) the tax, regulatory, interest rate and stock market environments.  Given our reading of the tea leaves, we think the following factors will drive and shape the industry in the decade ahead:

  • Increased regulatory and operational scrutiny
  • Diminished interest in hedge funds
  • Greater demand for private equity in the alternatives space
  • A battle between mega-firms and smaller, boutique style managers for investor monies
  • A headwind for buyout and other private equity strategies employing leverage

Increased regulatory and operational scrutiny is a near certainty.  Following on the heels of the financial crisis, investors have stretched in search of new opportunities as interest rates and spreads fell to historic lows.  Perhaps because of this, alternative asset categories have become more prevalent and regulators, accordingly, don’t want to drop the ball again.  The following areas will be under watch in the private equity realm:

  • Expense allocation between the funds of a given manager
  • The asset valuation policies of these funds
  • The co-investment policies of the manager
  • Fee transparency
  • Form PF and  marketing material scrutiny
  • An increased push by investors to outsource (and upgrade) manager operational capabilities

On balance, increased scrutiny should bode well for the growth of the industry.  While it will increase the costs of doing business, greater oversight will also allow investors not currently in the segment to feel more comfortable about future commitments.  At the same time, many service firms specializing in providing non-investment services such as Fund Administration and Compliance Outsourcing will help limit smaller managers’ cost increases while providing them with best in class services.

A diminished interest in Hedge Funds is quite possible.  Following a number of years of less than stellar results and a well-publicized decision by CalPERS, the largest public fund in the United States, and PFZW, the $150 billion Dutch Healthcare system, to divest from the category, we put a high probability on the following:

  • The potential for “follow on” moves (away from hedge funds) by smaller plan sponsors
  • A move away from the higher expenses associated with fund of fund programs and toward direct placement by those committed to the category, a continuation of a trend that is already underway
  • An opportunity for other alternative categories such as Private Equity to gain share 

The fact that we are likely to be in a low return environment for traditional asset classes (see our white paper, “Forecasting Return Expectations”) and investors have already taken on more risk in the quest for return, means many are now more likely to consider investing in what may be “new” asset classes to them.  With private equity allocations across large plans currently at 7% of assets, there is still room for the segment to gain share.  Also, given the generally fulfilled return expectations to date, private equity would seem to be a natural fit for many. 

Source: Bain & Company, Cambridge Associates

However, within the industry, where investors focus is still up in the air.  We are currently seeing different behaviors by investors in terms of the size of manager with whom they have comfort. 

  • The State of Wisconsin as well as Colorado Fire & Police have explicitly announced an intention to invest more with smaller managers where they feel interests are better aligned and where more opportunity to add alpha is possible
  • Los Angeles County ERS is also “looking at smaller managers”
  • CalPERS and the State of Michigan have already increased allocations with mega-firms citing the ease of oversight when managing large pools of capital

Ultimately, performance will likely determine which preference becomes dominant, though both are likely to co-exist for the near term.

Finally, given today’s historically low level of interest rates and credit spreads, along with the increased use of leverage in recent transactions, it will be more difficult for strategies dependent upon leverage to do as well in the future as they have in the recent past.  In fact valuation levels are approaching the last cycle’s peak.

Source: Bain & Company, S&P Capital IQ


At the end of the day the future looks bright for most areas within the private equity space.  Investors are underweight the asset class, private equity has historically met investor expectations and it is looked upon favorably by current investors.  With a low return environment for traditional asset classes a high probability, new sources of return will continue to be sought by plan sponsors.  Private equity has every reason to be high on most lists.

Thursday, August 14, 2014

It's All in the Math - Equity Returns over the Coming Decade (2 of 2)

While equity markets have more "moving pieces" than their fixed income counterparts, their longer-term outcomes can likewise be broken down into a handful of understandable and forecastable components. When approached in this disciplined manner, we see that returns from nearly every major equity region in the coming decade will be poor, with the UK faring better than most and the US likely to struggle.  

It is a given that there are only two ways to make money from an equity - either you are paid a stream of dividends, or the price another party is willing to pay you for your shares differs from the price you paid (Dividend + Price Change).  In general, the Dividend component is readily observable and tends to be less volatile while stock Price Changes are more volatile and, in the short-run, more unpredictable.

To better understand the portion of return due to Price Change, we can further decompose that piece into Earnings Growth per share and the P/E Ratio (i.e. the price one is willing to pay for each dollar's worth of those earnings).  Both are somewhat volatile, but less so than the overall Price Change itself.  To simplify further, I sub-divide the Earnings Growth component into Revenue Growth and the change in the profitability of those Revenues (i.e. the Profit Margin).  Taking all this together then, if we know with near certainty just four variables: Dividends, Revenue Growth, Profit Margins and the P/E Ratio, we know with certainty the return from an equity (or equity index).

Fortunately, for the purpose of our analysis, two of these components are relatively stable over a period as long as a decade (Dividend Yield and Revenue Growth), while valuation and profitability are more volatile -- and it is this change in the P/E Ratio and Margins that ultimately drives returns.  Thus a sensitivity analysis featuring these two unknowns is called for.
Some Background
Equity earnings tend to be cyclical over time (see chart) and gauging market value on a single, spot observation can be mis-leading -- especially when earnings are well above, or well below, their trend. As of June 30th, the P/E Ratio on trailing, reported earnings of the S&P 500 index was 18.2x, just above the longer-term norm of 17.1x (the median valuation since Dec 1959).  One might therefore conclude that the market is slightly overvalued. What is left out of such a simplistic analysis is that the earnings part of that calculation is not at its norm, but rather closer to a cyclical high.

Instances such as this occur when margins are historically high, even as they are understood to be generally mean-reverting.  Today, margins in the US and Japan are closer to one of these cyclical peaks, while those in the UK and Europe are not.
When valuation is compared to reported earnings per share, and the cycle is not taken into account, valuation (as measured by the PE Ratio) tends to be more volatile.  When the index price level is measured against trend EPS (that is, assuming a constant "normalized" margin), valuation extremes tend to disappear and a more stable relationship is observed.
Thus, a valuation analysis which adjusts for the margin's deviation from its norm and which assumes dividend growth in line with earnings (as long as the current payout ratio is near longer-term norms), revenue growth in line with historical trends (typically that of nominal GDP) and a valuation component (P/E ratio) that returns to its long-run median over a period of ten-years should provide a decent assessment of where returns are headed as cycles run their course.  Those who disagree with my assumptions of a return to normal margin can use the accompanying sensitivity tables and observe returns under a range of margin and P/E inputs - but refer to the above charts to understand what is in the "normal" (i.e. likely) range of outcomes.  I would direct doubters back to "The Profitability Illusion" (posted to this blog June 15, 2013) which discusses in some detail why over 2 percentage points of the current S&P 500 margin is illusory and unlikely to be sustained (all due to lower interest expense as opposed to better operational efficiency).  In any case, the range of returns can be illuminating and the dispersion of returns, not as wide as one might assume.

I turn first to the United States and use the S&P 500 index as a proxy for US Equities.  Over the past 50+ years, a median valuation of 17.1x earnings is the norm (I choose to use a median as opposed to an average because out-sized values can distort its calculation.  In full disclosure, the average P/E has been 17.6x).  Margins have averaged 6% for the past 50 years and have proven throughout to be mean reverting.  Today, though they stand near record highs of over 8% and in this analysis it is assumed they will slowly return to the 6% average.
For this exercise, we also assume 5.5% annual compounded nominal revenue growth (in line with historic norms) and a 2.08% annual return from dividends (normalized current yield). Putting this all together, our best guess return estimate for US Equities over the next 10 years is 2.0% per year.  If you want to assume record margins continue, you could up that expectation, but just to 5.0% (see table below). Under no reasonable scenario, are double digit equity returns in sight.

S&P 500 10-Year Return Estimation (5.5% Nominal Revenue Growth, 2.08% Annual Dividend, Various Margin and P/E Scenarios
    Normalized PE Ratio
  2.0% 13 15 17 19 21
Normalized Margin 4.0% -4.5% -3.1% -1.9% -0.9% 0.1%
5.0% -2.4% -1.0% 0.2% 1.3% 2.3%
6.0% -0.6% 0.8% 2.0% 3.2% 4.2%
7.0% 0.9% 2.3% 3.6% 4.7% 5.8%
8.0% 2.2% 3.7% 5.0% 6.1% 7.2%
Taking Japan next we conduct a similar analysis, using the historically lower 3.0% margin levels and 3.0% nominal revenue growth.  Though Japanese valuation data is distorted somewhat by 10+ years of a great bubble, we feel a normalized P/E ratio of 20.x, higher than that of the US, can be argued, though we show a range of 12.5x to 27.5x in the sensitivity below.  Still, a 3.0% return is the most likely annual outcome for the coming decade.
MSCI Japan 10-Year Return Estimation (3.0% Nominal Revenue Growth, 1.77% Annual Dividend, Various Margin and P/E Scenarios
    Normalized PE Ratio
  3.0%            12.5            15.0            20.0            25.0            27.5
Normalized Margin 2.0% -5.4% -3.7% -1.0% 1.2% 2.2%
2.5% -3.3% -1.6% 1.2% 3.5% 4.4%
3.0% -1.6% 0.2% 3.0% 5.3% 6.3%
3.5% -0.1% 1.7% 4.6% 6.9% 7.9%
4.0% 1.2% 3.0% 6.0% 8.3% 9.4%

Moving on to the European markets and the UK, we reach a somewhat happier, though still below historic, level of return expectations.  For the UK market we use similar revenue (5.5%) and normalized margin assumptions (6.0%) as we do for the US.  For the continent, I discount both revenue growth and margins by 0.5%, in line with historic observations.  Again, under a broad range of valuation and margin assumptions we see a most likely return for the UK of 5.7% and a most likely return of 3.9% for the continent.
MSCI UK 10-Year Return Estimation (5.5% Nominal Revenue Growth, 3.95% Annual Dividend, Various Margin and P/E Scenarios)
    Normalized PE Ratio
  5.5% 10 12 14 16 18
Normalized Margin 4.0% -1.7% 0.1% 1.6% 2.9% 4.1%
5.0% 0.5% 2.3% 3.8% 5.2% 6.4%
6.0% 2.3% 4.1% 5.7% 7.1% 8.3%
7.0% 3.8% 5.7% 7.3% 8.7% 10.0%
8.0% 5.2% 7.1% 8.7% 10.1% 11.4%
MSCI Europe ex UK 10-Year Return Estimation (5.0% Nominal Revenue Growth, 3.71% Annual Dividend, Various Margin and P/E Scenarios) 
    Normalized PE Ratio
  4.0% 10 12 14 16 18
Normalized Margin 3.5% -3.8% -2.1% -0.6% 0.7% 1.9%
4.5% -1.4% 0.3% 1.9% 3.2% 4.4%
5.5% 0.5% 2.3% 3.9% 5.3% 6.5%
6.5% 2.2% 4.0% 5.6% 7.0% 8.2%
7.5% 3.6% 5.5% 7.1% 8.5% 9.7%
It is almost certain that returns from the major developed equity markets are quite likely to remain in single digits - from somewhere near 2.0% compounded in the US to under 6% compounded in the UK – for the decade ahead. This realization, combined with similar fixed income expectations is that most plan sponsors will have great difficulty achieving their projected return assumptions of over 7.5%, even under the most optimistic of market conditions
Obviously a new perspective on managing and allocating funds is called for. This is why my July blog post, “The Task of Capital Allocators” is so important for every Plan Sponsor to consider.