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Capital Market Assumptions and Long-Term Return Forecasts in the Time of COVID

Groupthink or Logical Conclusions?

Asset management groups invest heavily in their long-term return forecasts, and the resultant publications always make for fascinating reading. Strategists have been reviewing their long-term return forecasts in the light of COVID-19 and the policy responses. Surprisingly, the dispersion of many asset class return forecasts is not as wide as might have be expected, given the significant potential for uncertainty that remains.

This selection of papers does see some variation in anticipated equity returns, with some asset managers thinking that the recent rally and relative valuation is now likely to depress future returns. Others see little or no impact on such long duration assets from even several years of declining earnings, believing that there is the possibility of equity risk premium compression. A consensus view (or groupthink!) has however emerged in the significantly lower return prospects anticipated for most types of bonds, while a majority of contributors are looking to alternative assets, and more specifically Private Equity, to provide the diversification and return benefits that appear unlikely from most mainstream assets.

 

weather changes

Capital Market Assumptions — Five year outlook 2021 edition (Northern Trust AM)

Northern Trust presents their recently updated 5-year return forecasts, prepared after the height of the Covid pandemic. As result of lingering negative economic effects, they expect financial market returns to be subdued for the next five years, with their 60/40 equity bond portfolio now expected to return just 3.9% annualized, compared to an actual 6.2% realized over the last five years.

5-year Expected Returns 2021-2025: Brave real world (Robeco, Sep 2020)

Robeco believes negative real interest rates will continue to influence financial markets for an extended period. They present return forecasts for all major asset classes, based on bear, base, and bull economic scenarios in this 5-year, 109-page outlook.

Capital Market Assumptions: Q3 2020 (QMA)

QMA updated their 10-year Capital Market Assumptions in June, just as ’second wave’ virus cases started to rise. Long-term forecasts for equity returns have been scaled back after the sharp rebound in markets and now stand at 6.3% compared with 7.2% at the end of Q1 2020. Emerging Market equity returns are still seen as a relatively bright spot.

Intermediate Capital Market Assumptions (UBS AM, Jun 2020)

UBS AM offers a range of four different economic scenarios (Bull, Base, Stagflation, and Stagnation), around which they build their 5-year return outlook. They fear continuing deglobalization and the consumer’s desire to save after an economic shock, offset somewhat by low interest rates and fiscal largesse. They are more bullish on equity returns, particularly China, while most expected bond returns decline from their mid-2019 edition levels.

Capital Market Assumptions: Q3 2020 (Invesco, Aug 2020)

For compliance reasons, this paper is only accessible in certain geographies

Invesco releases the June update of their 10-year return forecasts, in which their 60/40 portfolio has expected returns cut to 3.7%, a decline of 1% since the start of 2020. They suspect mainstream assets will find conditions challenging and look to Alternatives to help achieve return targets and to diversify risk.

Capital Market Assumptions (BlackRock, Aug 2020)

Blackrock presents their customizable time-horizon CMAs based on end Q2 2020 data. They see negative returns for most sovereign bonds, whilst the rally in investment grade (IG) bonds negates some of their early 2020 appeal. Equities face challenges too, as valuations appear to more than anticipate a significant snapback in earnings. Blackrock also sees the alternative asset class as a key contributor to multi-asset portfolio returns in coming years, with private equity a particular standout.

U.S. Capital Market Assumptions Survey (Horizon Actuarial Services, 2020)

Horizon Actuarial Services presents the findings from its Annual Survey of Capital Market Assumptions. 5- and 10-year forecasts are included from almost 40 respondents. There is a wide dispersion of expected returns across asset classes, but Alternatives are seen as offering the highest expected returns, with Emerging Market equities following a close second.

Capital Market Assumptions - June 2020 (PIMCO)

PIMCO’s updated Capital Market Assumptions forecasts a move towards certain credit sectors given that spreads remain relatively wide. Elsewhere, an anticipation of a weakening US dollar over time would tend to favour superior returns from Emerging Market assets, relative to U.S. assets, where both bonds and equities appear fully valued.

Estimating Global Investor Views with Reverse Optimization (Two Sigma, 2020)

Two Sigma present an interesting paper in which they use reverse optimization to build forward-looking return estimates, then they compare forecasted returns to actual realised returns. Not unsurprisingly, investors are anticipating a much tougher decade ahead across almost all asset classes, than the one they have just experienced.

Long-Term Capital Market Assumptions (BMO GAM, Jul 2020)

BMO GAM outlines their updated Capital Market Assumptions for a 10-year period. They highlight that some asset classes (equities) are very long duration, so sharp multi-year declines in earnings may not alter long-term expected returns by much. They reduce expected returns for bonds based on current and equilibrum interest rates moving lower, but remain sanguine about the prospects for equities. Like many, they prefer Alternatives, with Private Equity the standout choice.