Asset Allocation: Capital Market Assumptions For 2015 by Beth Vanney, Jeffrey Knight, ColumbiaManagement
- We retain very modest expectations for total returns from fixed-income assets based on the low level of yields combined with the expectation that interest rate policy will normalize within the next five years.
- We believe equities offer returns only slightly below their long-term averages based on expectations of ongoing economic growth and worldwide equity valuations that are not extremely expensive.
- We find that portfolios designed to rely more upon equity risk than fixed-income risk are more likely to succeed, on average, across the next five years.
For asset allocation decisions, we find great value in maintaining a long-term outlook for major asset classes. Twice a year, in fact, we conduct an extensive update of our five-year return forecasts for several asset classes. The purpose of this exercise is two-fold. First, taking a longer term perspective helps us to set strategic asset allocations and design portfolios for diverse investment goals. Just as important though is that maintaining long-term forecasts provides context for responding thoughtfully to daily swings in market.
Our capital market assumptions begin with our economic and interest-rate outlook. Since the specific timing and duration of economic expansion is difficult to forecast, we develop a central thesis along with strong and weaker potential recovery scenarios:
- Our central thesis is for real U.S. gross domestic product (GDP) growth rising in 2015 to 3%, a continued slow recovery in Europe with sagging growth in emerging markets.
- Our stronger recovery scenario involves real GDP growth accelerating in Europe that feeds Emerging Market growth with positive but more muted impacts to the U.S.
- Our weaker recovery scenario is for rising interest rates to tighten financial conditions in the U.S. and slow down growth.
From these economic scenarios and our analysis three key themes emerged:
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- Outside of high yield and emerging market debt, fixed income offers little return — with Treasuries and TIPS returning less than cash.
- An improving economy is good for risk assets.
- Markets will likely remain highly sensitive to the macroeconomic news and Federal Reserve policy.
The chart below shows our forecast five-year total average annual returns for several major asset classes (2015-19).
Source: Columbia Management Investment Advisers, LLC. Past performance does not guarantee future results.
From this chart we can extract a few of the major implications for strategic asset allocation over the next five years. First and foremost, we retain very modest expectations for total returns from fixed-income assets. This result derives directly from the low level of yields offered by major fixed-income asset classes combined with the expectation that interest rate policy will normalize within the next five years. We believe equities, meanwhile, offer returns that are only slightly below their long-term average levels. This forecast derives from an expectation of ongoing economic growth (and consequently, earnings growth), and worldwide equity valuations that are not extremely expensive. Accordingly, we find that portfolios designed to rely more upon equity risk than fixed-income risk are more likely to succeed, on average, across the next five years.