Our framework emphasises income payments across asset classes, as they are both readily measured and pivotal in determining returns. In addition, long-term history is available, and income is less subject to manipulation than accounting metrics.

We divide returns into three components. The first – income – is a tangible, known entity, but the others are subject to material misestimation:

1. Income: yield is historically the single most important explanatory factor for income-generating assets
2. Growth: the extent to which income is expected to change over time
3. Revaluation: the price per unit of income likely to apply at the end of the period (typically, 10 years)

This section is a summary of our approach; more detail may be found in the Methodology section.

Our current capital market assumptions (31 March 2022) highlight a real challenge for asset owners: we anticipate a traditional 60% global equity, 40% global government bond portfolio will deliver a muted 2.8% annualised return for the next decade in nominal terms, when hedged into US dollars. This is only marginally lower than our expectations from 12-months ago but close to 3% down from our forecasts in March 2020 in the immediate aftermath of the COVID sell-off. The uplift available from higher risk fixed income assets only modestly increases a balanced portfolio return expectations and brings higher correlations to equities. In such a low-return environment, we believe there is a need for considerable value-add from asset allocation and security selection decisions as well as from identifying investments that will benefit from structural growth tailwinds to achieve investment objectives.

Long-term predictions are fraught with uncertainty and open to error. We can, however, retrospectively apply our framework to assess its historical effectiveness. Because we focus on contextual information, we tend to evaluate effectiveness in terms of the reliability of the direction of the signal at market peaks or troughs; getting the broad direction of travel correct over a decade is a critical factor in an overall investment outcome.

The following chart identifies a variety of market peaks and subsequent troughs, stretching back to 1980, for each of developed market equity and global bonds. We then show the subsequent 10-year predicted returns at those points.

Expected returns can vary significantly depending on the point of the cycle

Source: Ninety One. Data is global since 2000; prior dates based on US outcomes. Bonds based on 10-year tenor

For example, the first point on the chart corresponds to November 1980 (roughly a market peak) followed by a trough in July of 1982. The relevant 10-year forecasts in each instance were:

Indeed, global equities tripled in the decade from November 1980, and rose fourfold from July 1982. The chart illustrates the desired pattern – riskier assets tend to have lower anticipated 10-year returns at peak than they do at the subsequent trough; conversely, the more defensive bond asset tends to do better at the peak than the trough. Interestingly, although this pattern is repeated over time, it does appear to be getting more compressed – perhaps due to the expansive liquidity provision over this period.

The following chart examines fixed income assets in nominal, local currency terms, for March 2022 versus a year prior:

Sovereign bond yields and credit spreads have both increased, leading to somewhat higher return expectations

Source: Ninety One

Actual and expected increases in policy rates from central banks have pushed global government bond yields up, which results in higher return expectations from both income and valuation with a smaller negative impact forecast from mean reversion. Yield curves have flattened which reduces the expected uplift from roll returns and means that at the global level the increase in expected returns over the past 12 months of 0.4% (in local currency terms) is slightly less than the increase in yields of 0.6% over the same period. In contrast with other economies, Chinese monetary policy has moved into an easing cycle helping yields on government bonds to decline over the last year and bringing down return expectations.

Credit spreads have also increased which has provided an additional source of higher return expectations across US Investment Grade and High Yield corporate credit and Emerging Market sovereign credit markets. The changes in spreads and in overall return expectations was smallest in the US High Yield market, with the result that lower returns are now expected from US High Yield credit than from US Investment Grade credit, which is discussed in more detail below. US High Yield credit spreads are still some way below their long term average levels, leading us to continue to forecast a negative return impact from mean reversion in credit spreads over the next ten years. By contrast, Investment Grade spreads are now in line with their average level and EM Sovereign spreads have risen to above average levels, creating an expectation of a modest uplift from mean reversion.

The following chart sets out our return forecasts in more detail, dissecting fixed income regions in the context of our Capital Market Assumptions framework pillars: income, growth and revaluation.

Income and Growth account for the bulk of return potential across fixed income

Source: Ninety One

Case study

The best performing equity markets over the last twelve months were the UK and US, both delivering double digit total returns. With the US market now making up over 60% of global market capitalisation, Global equity returns were similarly positive. Income and growth forecasts for Global equities were little changed over the last 12 months but total return forecasts have fallen as a result of expectations of a more negative impact from valuation reversion.

Europe ex UK and Japan both delivered more modest positive returns over the last year but the real underperformers were in Emerging Asian equity, most notably China which declined more than 30% over the 12 months. This decline has seen return expectations for income and revaluation increase materially for both China and Global Emerging Markets. This is slightly offset by a downward revision to the structural growth forecast for the Chinese market which is explained in box 2 below.

Global equity return forecast has fallen further but regional divergence has widened with expected returns rising across Asian and Emerging Markets

Source: Ninety One

When we look at the components of our forecasts for equities, we see that the entire anticipated return (bar the UK and Japan) is driven by the growth assumptions over the next decade as the current level of income is low by historical standards and more than offset by the drag expected from mean reversion in valuations. At the same time, our growth forecasts imply a meaningful deceleration in dividend growth from the rates achieved over the last 20 years. In box 1, we study the drivers of dividend growth, showing how the robust growth of the last two decades has been achieved and why it is unlikely to be repeated in the coming decade.

China and Emerging markets offer returns which are particularly attractive when compared to the lower expected returns in the US and Europe ex UK

Source: Ninety One

Case study

While we calculate our expected returns on a “local currency” basis, we appreciate that clients need to take a currency decision – whether to hedge or not. We therefore show each of our equity and fixed income assumption on these two bases – hedged (using interest rate parity) and unhedged / converted (based on real exchange rate reversion):

Equity expectations

Fixed Income expectations

Source: Ninety One

Predicting long-term returns is fraught with difficulty; market values are not only determined by fundamentals, but also sentiment and exogenous events. We aim to keep things as straightforward as possible, and therefore focus on fundamentals. We:

• Favour simplicity to capture the key drivers and accept wide uncertainty bands
• Strive for consistency with the investment process, focussing on cashflows
• Aim to be comprehensive across asset classes, with the ability to extend within

We divide returns into three components. The first is known, more readily measured and widely available in the public domain, but the other two are subject to material misestimation:

• Income – yield is the single most important explanatory factor for income-generating assets
• Growth – the extent to which income will likely change over time
• Revaluation – the price per unit of income likely to apply at the end of the period

By default, we assume a 10-year investment horizon, to reflect the fact that we are long-term stewards of client capital. We do not consider tax, given different requirements pertaining to different mandates. The approach we outline is our baseline estimate; we may make judgemental adjustments to the underlying drivers if warranted.

Here we set out our methodology for equities, fixed income and currencies:

¹ Where a market has a high proportion of overseas sales, we use the average of the local and global nominal GDP per capita trend growth rates.
² Uses the average of local and global issuance trends given lower predictability for more specific universes and a belief in global convergence. Overrides may also be applied where local figures are volatile.
³ Yield to Maturity based on notional 10-year bonds (except in the case of High Yield, where 5-year bonds are used)
⁴ Credit spread curve data tends to be unreliable; we presume because the notion of quality changes with tenor. We therefore assume a constant spread
⁵ This is an implicit allowance for rebalancing of the constant maturity bond
⁶ Based on Moody’s default data

Equities

Equities are assumed to be purchased on a buy-and-hold basis. We use relevant MSCI indices to reflect the regions.

We proxy income with dividends. While many equity investors prefer to focus on earnings, we regard dividends as being less subject to manipulation – these distributions are a tangible payment that is publicly available information – and therefore more reflective of the long-term fundamental cash-generating properties of the broad market. While other metrics (e.g. free cash flow) have evolved, they do not yet have similarly long history.

The history of US dividends stretches back over a century

Source: Shiller, U.S. Stock Markets 1871-Present and CAPE Ratio

In this context, growth primarily relates to an equity market’s ability to increase dividends over time. GDP per capita has historically proven to be a reasonable proxy for dividend growth – and a closer match than GDP itself, as illustrated below. We simply allow for the global effects of growth based on the extent of non-domestic revenue exposure, assuming developed market growth is an average of local and global growth, while emerging market growth is wholly determined locally⁷. Growth is proxied based on trailing 15-year trend growth, a period that captures the secular effects of a couple of cycles.

Nominal GDP per capita has proved a useful proxy for dividend growth

Source: Shiller, U.S. Stock Markets 1871-Present and CAPE Ratio; Williamson, “What was the US GDP Then?”, MeasuringWorth

Lastly, we factor in an adjustment for revaluation. We believe that valuation acts as a gravitational pull over long periods; however, changes in market composition and dynamic means that this is not a static metric. We use the price-dividend ratio and trend dividend yield as our valuation metric, assuming this reverts to a long-term (15-year) average. This allows us to both maintain consistency with our income-focused framework, and smooth out the cyclical nature of dividends. While we acknowledge full reversion is unlikely – prices tend to overshoot both on the upside and the downside – this simplification remains conceptually sound on average, as can be seen in the graphic below.

The actual price-dividend reverts reasonably neatly to the trend average over time

Source: Shiller, U.S. Stock Markets 1871-Present and CAPE Ratio, internal calculations

Fixed Income

Our portfolios target specific duration contributions when allocating to bonds; therefore, we feel it appropriate to use constant maturity bonds as the basic building block. We further deconstruct bonds into risk-free and spread components, enabling us to cover both sovereign and corporate debt.

Income assumes the par yield of the bonds, typically for a notional 10-year bond. Regional indices are then generated by using the weighted average of the relevant country inclusions, as illustrated below.

Regional indices are generated using a weighted average of the relevant countries

Source: Ninety One calculations based on BAML indices

We define growth as being the roll yield obtained from consistently rebalancing the portfolio to maintain a constant maturity. So, for example, with a typical contango yield curve where the longer-term price is higher than the short-term, after one year the bond holder would sell the lower yielding, higher priced nine-year bond to buy a higher yielding, lower priced 10-year bond. Implicit in this view is a belief that the shape of the yield curve remains relatively consistent (including a constant spread component for credits).

Growth is the roll yield from consistently rebalancing the portfolio to maintain a constant maturity

Source: Ninety One. This graphic is for illustrative purposes only.

Revaluation is easier for government bonds than corporates; the former typically have liquid, traded markets enabling us to infer the forward market expectation of pricing. The implicit belief that markets converge to these expectations seems reasonable as a baseline for active management decisions. Credit spreads are, however, less broadly available; we therefore assume that the excess spread reverts to its 15-year average.

Currency

We calculate currency returns in local currency. As explained in the currency section, we then adjust on two bases:

1. Hedging – Since it is common practice to hedge currency risk, and these costs are largely known at the date of investment, we use this as our base case. We assume that the position is hedged at inception for the 10-year horizon (essentially ignoring the small cash-flow differences that might occur), using covered interest rate parity. We derive the relative hedging cost from the zero-coupon bond yields corresponding to the investment horizon.
2. Conversion – Many investors are willing to bear the currency risks, and therefore hold their assets unhedged. To proxy this, we use real effective exchange rates – i.e. adjusting the currency cross rates for relative inflation movements. We assume these exchange rates revert to their 15-year averages with an allowance for the difference in inflation targets, thereby allowing some currency mean reversion.

⁷ Based on the Morgan Stanley Global Exposure Guide 2019, Developed Markets tend to average c. 40% foreign exposure, while Emerging Markets are sub 20%.

Q In equities, why have you used GDP per capita and not GDP itself?

GDP per capita has historically proven to be a reasonable proxy for dividend growth.
This is in spite of the fact that the relationship between fundamental company growth, in aggregate, and country-level economic growth is weaker than might otherwise be expected due to compositional mismatches. For example, GDP includes both private and public sector outputs; however, only the former are captured in aggregate via listed equities. Similarly, economic growth tends to be locally focussed, whereas listed companies often have substantial global operations.

Q Have you considered the impact of issuance or other corporate activity on the growth of income within equities?

The impact of net issuance is important, as it reduces the participation in economic growth by owners of equities. Items such as buybacks tend to be stable – their attractiveness is based on the regulatory and taxation basis applicable at a point in time, which tend to change infrequently. Other sources may be more volatile – for example, market changes due to M&A activity, views on the appropriateness of stock-based compensation, or even secondary issuance due to market stress. We infer the net issuance impact from the change in MSCI Index Divisor over time.

Q What assumptions do you make for credit defaults?

We make allowances for credit defaults with the bond growth rate, using Moody’s long-term default histories. We use the Moody’s country rating for specific country sovereign debt, and the ratings banding for credit indices. By assuming that a “AAA” rating has similar meaning in both sovereign and corporate contexts, we can reasonably proxy a wide array of indices.

Q Given that Capital Markets Assumptions have so much associated uncertainty, what is the benefit of even attempting?

We see two key benefits:

• A clear understanding of return drivers enables sharper thinking about potential asset class outcomes, including under various scenarios.
• Insight into the likely direction and possible magnitude of returns helps our clients understand what outcomes may be reasonable

Q How effective have your Capital Market Assumptions been?

As can be seen here, the Capital Market Assumptions have shown clear differences between market troughs and market peaks.

Q Why use dividends / price-dividend rather than earnings and the more conventional price/earnings?

Dividends, being physical payments to share-holders, are less subject to manipulation that earnings (which are only book profits). We believe that results in stronger conclusions.

In addition, data sets tend to have a longer history of dividend payments, enabling us to consider the approach in a broader variety of historic contexts.

Q What key factors items are not considered in your approach?

Our Capital Market Assumptions assume that the fundamental market drivers remain unchanged. They therefore ignore exogenous shocks – e.g. climate risks and geopolitical events (although we may update our assumptions in the event of a material shock).

We currently focus on single-asset return outcomes; therefore, we make no comment about potential changes in cross-asset correlations or asset-specific volatilities.

We do not adjust for individual client circumstances either: client tax status may impact the relative attractiveness of asset classes.

Q Why do your growth assumptions look so much more pessimistic than the last twenty years of equity and / or dividend growth?

For corporate cashflows to continue growing at a significantly faster rate than the broad economy, one of three things needs to occur:

• Revenue grows faster than the broad economy – e.g. via the launch of new products which are far superior to competitors, or through the capture of new market segments (including internationalisation). The former should not make a difference at the aggregate market level (one competitors revenue growth comes at the expense of another) but the latter may occur through, for example, internationalisation. That is why we link growth to a mixture of local + global GDP
• Costs fall (or, equivalently, margins increase) – e.g. via lower tax rates, more efficient use of resources, economies of scale, or regulatory capture. We think further margin expansion is challenging as tax decreases have likely reached their nadir, while regulatory capture cannot happen indefinitely. Since we have not yet found a reasonable long-term (10-year) predictive proxy, we prefer not to forecast this element, i.e. assuming that margins remain roughly constant.
• Business reinvestment increases (when returns are higher than the cost of capital) – If businesses are prioritising their investment, marginal investments will offer a decreasing rate of return, such that ultimately returns converge to cost of capital. If not, we’d expect competitors to enter. Again, a natural limit exists. Again, in the absence of a reliable predictive proxy, we essentially assume that pay-out ratios remain constant.

In short – because we focus on variables that have both been historically predictive and have a sensible fundamental interpretation, we continue to favour GDP as a predictor (implicitly, of revenue). We continue to actively research appropriate variables for margins and pay-out ratios; however, in an environment where we think each faces headwinds, we are comfortable to continue with our simplifying assumption.

Q Why a 10-year horizon?

As long-term custodians of our client’s capital, our focus is on helping our clients achieve suitable outcomes.

In addition, we require a timeframe long enough for fundamental drivers to be expressed, in-spite of cyclical noise.

Q How often are your assumptions updated?

We intend to update the Capital Market Assumptions twice each year – after the March- and September quarter-ends.

We may also provide intra-period updates if we believe a market event is significant enough to materially change the 10-year outlook. For example, we released an internal update in late March 2020 to highlight the potential upside from equities and credit after the initial corona-induced market collapse.

Q Why nominal (and not real) returns?

Inflation is notoriously difficult to predict; so much so, that our work suggested that nominal forecasts were often more reliable than real forecasts.

Q Why two currency bases – hedged and converted?

Both are common approaches to international exposure – some prefer hedging, whereas others are prepared to bear the resultant currency risk. We therefore thought it appropriate to include both so, irrespective of preference, the assumptions would be useful.

Q How are CMAs used within the Multi-Asset process?

Capital Market Assumptions are a framework for thinking about reasonable client outcomes and providing broad market context. These figures do not directly result in individual investment decisions.

Importantly, the Capital Market Assumptions represent the view of the Multi-Asset Capability within Ninety One; other investment teams are free to disagree.

Q Are the assumptions purely systematic?

We wish the framework to be consistent over time to help sharpen thinking on asset-level drivers; therefore, where possible, we prefer to use set assumptions.

We do, however, reserve the right to override specific assumptions where there is a strong market-specific reason to do so.

Q Why do you not predict macro-economic variables within the Capital Market Assumptions?

We wish to understanding potential client outcomes over the long-term; therefore, our focus is on identifying those drivers which best explain and predict such outcomes. As can be seen in our framework, that can be done without specific macro-economic views.