Our longer-term asset class forecasts are forward-looking estimates of total return and risk premia, generated through a combined assessment of current valuation measures, economic growth, inflation prospects, ESG considerations, yield conditions as well as historical price patterns. We also include shorter-term return forecasts that incorporate output from our multi-factor tactical asset allocation models. Outlined below is the process we use to arrive at our return forecasts for the major asset classes.
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The starting point for our nominal asset class return projections is an inflation forecast. We incorporate both estimates of long-term inflation and the inflation expectations implied in current bond yields. US Treasury Inflation-Protected Securities (TIPS) provide a market observation of the real yields that are available to investors. The difference between the nominal bond yield and the real bond yield at longer maturities furnishes a marketplace assessment of long-term inflation expectations.
Our long-term forecasts for global cash returns incorporate what we view as the normal real return that investors can expect to earn over time. Historically, cash investors have earned a modest premium over inflation but we also take current and forward-looking global central bank policy rates into consideration in formulating our cash forecast.
Our return forecasts for fixed income are derived from current yield conditions together with expectations as to how real and nominal yield curves will evolve relative to historical precedent. We then build our benchmark forecasts from discrete analysis of relevant maturities. For corporate bonds, we also analyse credit spreads and their term structures, with separate assessments of investment grade and high yield bonds. We also take into account the default probability for high yield bonds in the foreseeable future.
Figure 1: Forecasted Long-Term Annualised Return
Our long-term equity market return forecasts combine estimates of real return potential, derived from historical and current dividend yields, forecasted real earnings growth rates, expected share issuance or buyback yield, and potential for expansion or contraction of valuation multiples. Our way of estimating real earnings growth rates incorporates forecasts of GDP levels. Across both developed and emerging markets, variations in labour, capital and productivity levels result in region-specific differences in the GDP estimates, allowing for more region-appropriate forecasts for both developed and emerging market equities.
Another important feature of our equity forecasts is that they include elements of ESG through leveraging State Street Global Advisors’ R-Factor scores. Improvements in a country’s aggregated and normalised R-Factor scores are used to incrementally reduce its risk expectations within the forecast and the other way around.
Smart Beta forecasts are developed using MSCI World index forecasts as a starting point and adding expected alpha and beta adjustments as appropriate.
Our long-term forecast for private equity is based upon past performance patterns of private equity funds relative to listed equity markets and our extrapolation of these performance patterns on a forward basis. According to several academic studies1,2,3 the annual rate of return of private equity funds over the long term appears to be largely in line with that of listed equities after appropriate adjustments for leverage are made. Private equity funds seem to have been outperforming relative to listed equities before fees, but generally in line with them (on aleverage-adjusted basis) after fees.
Real Estate Investment Trusts (REITs) have historically earned returns between bonds and stocks due to their stable income streams and potential for capital appreciation. Hence, we model it as a blend of two approaches. The first approach is to apply the average historical spread of the yields over Treasuries to forecast the expected return. The second approach is to account for inflation and long-term capital appreciation with the current dividend yield.
Our long-term commodity forecast is based on the level of world GDP, as a proxy for consumption demand, as well as on our inflation outlook. Additional factors affecting the returns to commodity investors include how commodities are held (e.g., physically, synthetically, or via futures) and the various construction methodologies of different commodity benchmarks. Futures-based investors have the potential to earn a premium by providing liquidity and capital to producers seeking to hedge market risk. This premium is greatest when the need for hedging is high, driving commodities to trade in backwardation, with future prices that are lower than spot prices. When spot prices are lower, however, the market is said to be in contango, and futures investors may realise a negative premium.
We believe that over the long term, prices are anchored to some sort of a slow-moving, fundamentals-anchored process, while in the short term, these same prices cycle quasi-randomly around such anchors. Thus, the returns on most financial assets can be effectively separated into a long-term component linked to economic fundamentals and a transient part linked to “excess volatility” or other noise. Such property of asset returns rhythms nicely with the investors’ need to balance strategic portfolio optimality with the short-term risk control. With that in mind, we expanded our Long-Term Return Forecasts to include long-horizon risk estimates alongside ordinary, short-horizon ones.
Figure 2: SSGA Asset Class Return Forecasts
Important Risk Information
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
This document contains certain statements that may be deemed to be forward-looking statements. All statements, other than historical facts, contained within this article that address activities, events or developments that SSGA expects, believes or anticipates will or may occur in the future are forward-looking statements.
These statements are based on certain assumptions and analyses made by SSGA in light of its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which are beyond SSGA’s control. Readers are cautioned that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
Investments in small and mid-sized companies may involve greater risks than in those of larger, better known companies, but may be less volatile than investments in smaller companies.
Companies with large market capitalisations go in and out of favour based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalisations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalisations.
Hedge funds are typically unregulated private investment pools made available to only sophisticated investors who are able to bear the risk of the loss of their entire investment. An investment in a hedge fund should be viewed as illiquid and interests in hedge funds are generally not readily marketable and are generally not transferable. Investors should be prepared to bear the financial risks of an investment in a hedge fund for an indefinite period of time. An investment in a hedge fund is not intended to be a complete investment program, but rather is intended for investment as part of a diversified investment portfolio.
Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets.
The views expressed in this commentary are the views of the SSGA Investment Solutions Group through the period ended March 31, 2023 and are subject to change based on market and other conditions. The opinions expressed may differ from those of other SSGA investment groups that use different investment philosophies.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Smart Beta strategy does not seek to replicate the performance of a specified cap-weighted index and as such may underperform such an index. The factors to which a Smart Beta strategy seeks to deliver exposure may themselves undergo cyclical performance. As such, a Smart Beta strategy may underperform the market or other Smart Beta strategies exposed to similar or other targeted factors. In fact, we believe that factor premia accrue over the long term (5–10 years), and investors must keep that long time horizon in mind when investing.
The value of the debt securities may increase or decrease as a result of the following: market fluctuations, increases in interest rates, inability of issuers to repay principal and interest or illiquidity in the debt securities markets; the risk of low rates of return due to reinvestment of securities during periods of falling interest rates or repayment by issuers with higher coupon or interest rates; and/or the risk of low income due to falling interest rates. To the extent that interest rates rise, certain underlying obligations may be paid off substantially slower than originally anticipated and the value of those securities may fall sharply. This may result in a reduction in income from debt securities income.
Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.
Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general.
Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).
Investing in commodities entails significant risk and is not appropriate for all investors.
Commodities investing entail significant risk as commodity prices can be extremely volatile due to wide range of factors. A few such factors include overall market movements, real or perceived inflationary trends, commodity index volatility, international, economic and political changes, change in interest and currency exchange rates.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax or financial advisor.
Past performance is not a reliable indicator of future performance.
Investing involves risk including the risk of loss of principal.
Diversification does not ensure a profit or guarantee against loss.
Asset Allocation is a method of diversification which positions assets among major investment categories. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
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All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio’s specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio’s ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
Responsible-Factor (R Factor) scoring is designed by State Street to reflect certain ESG characteristics and does not represent investment performance. Results generated out of the scoring model is based on sustainability and corporate governance dimensions of a scored entity.
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Exp. Date: 04/30/2024