A guide to the Long-Term Capital Market Return Assumptions
Michael Feser,
Global Investment Director and Portfolio Manager, GIM Solutions
Anthony Werley,
Chief Portfolio Strategist, Endowment and Foundations Group
David Shairp,
Global Strategist and Portfolio Manager, GIM Solutions–Global Multi-Asset Group
Introducing Our 2015 Assumptions
- We are pleased to present our 2015 Long-Term Capital Market Return Assumptions (LTCMRAs), our annual assessment of the long-term outlook for all major asset classes and alternative strategy classes.
- The 2015 edition is once again divided into three main sections. The first section (Thematic Articles: Considerations for Long-Term Investors) contains six thematic articles that analyse a number of market trends and other strategic asset allocation issues, as well as specific aspects of the theory and methodology behind the numbers.
- The six articles in the second section (Rationale and Methodology Articles: The Thinking Behind the Numbers) discuss the factors, principles and reasoning underlying our projections for asset classes, as well as our macroeconomic and volatility/correlation assumptions.
- The final section (Long-Term Capital Market Return Assumptions) provides the numerical assumptions themselves laid out in three variations, each in an easy-to-reference matrix format, with data sets for U.S. dollar- euro- and sterling-based investors.
- While many aspects of our process have evolved over the years, our goal has remained the same: to create return and risk projections—through a transparent, comprehensive and consistent process—that are useful to investors when making, reviewing and/or analyzing strategic asset allocation decisions in a multi-asset context.
Section I: Thematic Articles Overview
In this year’s first thematic article (On the Road to Normalisation), David Shairp and Michael Hood review how far we have travelled down the road back to normality in the six years since the Federal Open Market Committee (FOMC) started the great monetary policy experiment that helped to end the Great Recession. The article further explores how secular trends, such as demographic headwinds and the state of domestic as well as global rebalancing will affect the long-term growth and inflation outlook for the major economies globally.
In the second thematic article (How Dilution and Share Buybacks Impact Equity Returns), Patrik Schöwitz and Michael Albrecht shed light on an often overlooked aspect when projecting equity market index level returns: the aggregate impact of shareholder dilution and share buybacks on the total index return. Their analysis identifies the impact of this practice in different markets and assesses the extent to which increased buybacks—in lieu of dividends—will reduce the rate of shareholder dilution in the future. A favourable side effect of this enhancement to our equity methodology is that it also improves our projection for the portion of shareholder returns that is generated through dividends—an important consideration for income-oriented investors.
While the eurozone and Japan are still actively pursuing easier monetary policies to revive growth, the monetary policy cycle is turning in the U.S. and the UK. Our third thematic article (Forward Guidance: Estimating the Path of Fixed Income Returns) dissects the implication of policy normalization on returns from bonds with varying maturities. Based on the yield curve of the UK government bond market, Rupert Brindley’s analysis shows how to use the forward rate of interest concept to identify the policy risk term premium, and how liability-aware investors in particular can apply it to identify opportunities for enhancing returns along the yield curve. The framework itself is universal and can be applied to other government bond markets around the globe.
Our fourth thematic article (Assessing What Is “Fair” in Corporate Credit Spreads) quantifies the interaction between macroeconomic and credit fundamentals as well as risk appetite and volatility and credit spreads over the course of a market cycle. The unconventional monetary policies employed by central banks over the last several years have successfully helped to calm financial market volatility and normalize risk premia for liquid assets even while macroeconomic activity trails pre-crisis levels. Investors may therefore question whether corporate credit spreads have tightened beyond fundamentally justifiable levels and how rate normalisation will affect credit spreads. The fair value model presented by Grace Koo in this article provides a framework to answer these questions.
The fifth thematic article (The Globalization of Inflation) sees Paul Sweeting and Alexandre Christie explore to what extent inflation can be considered to be a global phenomenon. While it is our central case that inflation in the developed world will remain range-bound and several deflationary factors still need to be overcome in the near term, there are a significant number of investors who invest relative to a stream of real liabilities. Given the limited availability of inflation-linked securities across maturities and their relatively extreme pricing by historical standards in some markets, Paul and Alexandre’s article looks at the trade-offs and opportunities for investors willing to hedge domestic inflation through investing in overseas inflation index-linked bonds instead of domestic ones.
In this year’s sixth and final thematic article (One of the Laggards of Normalization), Dave Esrig and Anthony Werley take a closer look at U.S. value-added real estate. The compression of risk premia in recent years has predictably started with less volatile assets before progressing to more volatile assets, but more significantly, this trend has also strongly favoured assets with higher perceived liquidity compared with less liquid ones. This article analyses the unique demand and supply dynamics of this cycle and the resulting investment opportunities. By further assessing the impact of both normal cyclical factors and anomalous factors on valuations, the article makes the case for the existence of a significant risk premium in the value-added real estate asset class.
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