Tuesday, October 29, 2019

Robeco long-term asset forecasts - It is not pretty

Robeco Asset Management issued a good forecasting piece on the expected returns for traditional assets over the next five years called "Escaping the Hall of Mirrors 2020-2024 Outlook". It is thoughtfully done although any forecast are sure to a large forecasting error terms. They provide a well-researched process for arriving at their conclusions, so these numbers are grounded in current best thinking on expected returns for equities, bonds, and credit. 

There will be surprises in what will happen over the next five years, but Robeco provides a good benchmark for discussion. Their expectations are not assuming any forecast for the business cycle. They use current modeling of forward rates, term premium, expected inflation, and carry for fixed income. Current conservative valuations in equities are used to extrapolate expected risk premia. Robeco's views on equity and bond overvaluation is actually tempered versus many other asset managers.

The likelihood that investors will get anything close to an expected discount rate of 7% is very low. Even a 4-5% number for a combined stock bond portfolio may be a stretch without takings risks. The only way a strong portfolio return can happen is if equities show a strong jump to higher valuations and bonds move to further negative levels and investor get a capital gain. This only means is that the day of revaluation reckoning is pushed into the future. 

The only approach to avoid this low return scenario is to engage in further diversification and have some strategy for reducing tail risk. The Robeco high returning assets are emerging market equities, emerging market bonds, commodities, and real estate. They do not forecast at hedge fund or alternative risk premia. This may seem obvious, but the cutting loses through active hedging is the only way to protect against low expected returns given current high valuations.  

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