A clear divergence has developed between fixed income assets, where prospective returns have moved up significantly over the course of the last two years, and in equities, expected returns remain low relative to long- run historical norms and well below the potential returns observed during the troughs of significant historical bear markets.

Our current Capital Market Assumptions (31 March 2024) remain somewhat bearish in aggregate: we anticipate that a traditional 60% global equity, 40% global government bond portfolio will deliver a 3.9% annualised return for the next decade in nominal terms, when hedged into US dollars. This is lower (-1.0%) than our last update six months ago. Judicious market choice in each of equity and fixed income might increase returns, albeit potentially reducing diversification.

We continue to see 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.

Forecasts are inherently limited and modelling involves risks, assumptions and uncertainties, they are forward looking and are not guarantees nor a reliable indicator of future results. Actual returns could be materially higher or lower than projected. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance.

Source: Ninety One proprietary Capital Market Assumptions as at 31 March 2024.
These estimates are gross of fees (returns can be reduced by management fees and other expenses incurred) and reflect the view of Ninety One’s multi-asset team, whilst the views of other teams across Ninety One may differ. Details on our Capital Market Assumptions methodology available upon request.

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 figure below identifies a variety of market peaks and subsequent troughs, stretching back to 1980, for each of developed market equity and global bonds¹. We then show the subsequent 10-year predicted returns at those points.

Figure 1: 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 previous 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.

¹ Developed market equities = MSCI ACWI and global bonds = FTSE WGBI.

The following chart examines fixed income assets in nominal, local currency terms, for March 2024 versus our last update, six months ago:

Figure 2: Sovereign bond yields are relatively stable; however, credit spreads have continued to tighten
10 year local currency, log return forecast

Source: Ninety One (internal calculations based on Bloomberg and Moody's data).
EM HC debt = Emerging markets hard currency debt; EM LC debt = Emerging markets local currency debt; US IG = US investment grade; US HY = US high yield.

The total level of income available to investors has generally stabilised over the last six months, with continuing compression of credit spreads.

Risk-free yields at quarter-end were consistently lower than those implicit in forward yield curves, leading to negative revaluation effects across the board. Consistent with our last update, tight monetary policy means that yield curves remain inverted in most markets at the short end, with Japan and China being key exceptions because of ongoing loose policy. In most government bond markets, there is a positive roll return available which largely offsets the expected drag from revaluation.

Credit spreads continued to tighten, reaching similar levels to those of December 2021.

Currency remains an important consideration. The US dollar real effective exchange rate is well above the historic average level and US interest rates are higher than in other developed markets, implying likely positive returns for US dollar based investors holding international assets on either a converted or hedged basis.

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.

Figure 3: Income accounts for the bulk of return potential across fixed income

Source: Ninety One (internal calculations based on Bloomberg and Moody’s data).

To give a further understanding of the relative attractiveness of prospective returns across fixed income markets, it is helpful to consider our return forecasts in the context of the historic range of outcomes for each market.

Figure 4: Historic returns

Source: Ninety One proprietary Capital Market Assumptions as at 31 March 2024. Estimates are nominal, hedged into USD, gross of fees and ignore alpha. Modelling involves risks, assumptions and uncertainties. These estimates reflect the view of Ninety One’s multi-asset team, while the views of other teams across Ninety One may differ. Performance does not guarantee future results. Actual returns could be materially higher or lower than projected. For information on our Capital Markets Assumptions methodology, please see Important information.

• The chart above shows the distribution of historic 10-year rolling geometric returns, hedged into USD, for the assets (in the box-and-whisker plot) versus the current forecast (yellow bar).
• The body of the box represents the interquartile range, while the ‘whiskers’ extend to the maximum and minimum historic rolling 10-year returns.
• It is evident that, bar EM LC debt (second quartile) and US government bonds (just above the lower-quartile cut-off), expected fixed income returns are predicted to be consistently in their lowest quartile.

The Bank of Japan’s monetary policy meeting in March 2024 created barely a ripple in financial markets but marks a historic moment in Japan’s economic history as the central bank declared victory in the decades- long battle with deflation and ended the world’s longest running experiments with both negative interest rates and explicit caps on long-term government bond yields. It is vital to consider the implications of this policy shift for our capital markets assumptions on the prospective returns from Japanese assets and the Japanese yen as there is the real possibility that we have passed through an inflection point where the decade ahead will look very different from the recent past.

The past-policy divergence

To get a clear picture of the drivers of Japanese markets we have to start with the remarkable divergence in monetary policy witnessed as central banks raised interest rates and stopped or reversed asset purchases in response to the wave of inflation which washed around the world starting in 2021. Throughout this global policy tightening cycle, Japan stood alone, maintaining exceptionally loose monetary policy with negative interest rates, yield curve control and asset purchase programmes all still in place.

Figure 5: Policy rates – US, eurozone and Japan

Source: Ninety One, Bloomberg, 31 March 2024.

This policy divergence drove a large depreciation in the Japanese yen and significant outperformance of Japanese equities. The equity outperformance was a local currency phenomenon only – in common currencies, returns were very similar in Japanese and international equity markets. Japanese equity returns were supported by robust fundamentals as Japanese corporates enjoyed stronger profit growth over this period and further progress was made on corporate governance reform but currency impacts were by far the largest driver of outperformance in this period.

Figure 6: US dollar vs. Japanese yen and Japanese equities relative returns (rebased to 100)

Source: Ninety One, Bloomberg, 31 March 2024.

This outperformance has had a major impact on the prospective equity returns as viewed through our Capital Market Assumptions. In our Q1 2022 update, the forecast return for Japanese equities was 4.7% per annum in local currency, significantly above the forecast of 2.9% per annum for global equities ex-Japan. This gap has now completely closed with both forecasts fractionally above 3% per annum for the next ten years. The change has been driven by the relative re-rating of the Japanese equity market over the last two years, with our forecasts moving from expecting a slight uplift to returns from revaluation to currently implying a negative impact from mean reversion of Japanese equity valuations. The Japanese market is still viewed as slightly less expensive than global equities ex-Japan, but the differential is much less marked.

Figure 7: Japan equities and Global equities ex-Japan forecasts

Source: Ninety One, Bloomberg, 31 March 2024.

The impacts on prospective currency returns have been even more dramatic. The fall in the value of the yen has taken the Japanese real effective exchange rate to the lowest level since at least 1970. As a result, our forecast for returns of the Japanese yen against the US dollar has increased to +4.5% per annum.

At the same time, the interest rate differential between the US and Japan – used to estimate the impact from hedging Japanese yen exposure into US dollars – has widened to +3.4% per annum. Notably, for a US dollar-based investor, the currency return impact from investing in Japanese assets is expected to be larger than the local currency total return delivered by either Japanese or global equity markets.

Figure 8: Japan real effective exchange rate

Source: Ninety One, Bloomberg, 31 March 2024.

The future-policy convergence

As described above, the recent announcement by the Bank of Japan marks the first move to tighten Japanese monetary policy in the post- GFC era and, barring a new economic shock, we should expect further modest tightening steps over time. Importantly, this is happening at the same time that other major central banks have either already started to loosen policy or clearly stated that interest rates are at a peak for this cycle and will be reduced in the near future. There is scope for this policy convergence to move further and faster than current market expectations where growth and inflation rates decline most sharply. As we have previously detailed, the eurozone stands out as an economy where this scenario seems particularly likely.

One clear implication of this policy convergence is that lower interest rate differentials would sharply reduce the attractiveness of carry trades funded from yen. A related but less discussed implication relates to capital allocation decisions by both Japanese and global investors.

From the perspective of international investors, there has been increasing interest in the Japanese equity market as the end of the deflationary era and a renewed focus on corporate governance reforms have helped to drive improved profitability for Japanese companies. As noted above, this improved fundamental performance has not translated into outperformance of global equity markets in common currency terms as the local currency outperformance has been offset by the devaluation of the Japanese yen. With the yen now reaching such low levels of valuation relative to history, our forecasts suggest that over the next ten years international investors in Japanese equites are likely to earn positive returns both from the underlying equity market and from currency appreciation. The size of the expected currency returns is such that the expected return on Japanese equities is the highest of any major region when converted into a common currency.

Figure 9: Regional equity returns in local currencies and in US dollars

Source: Ninety One, Bloomberg, 31 March 2024.

From the perspective of a Japanese investor, the combination of a very cheap real effective exchange rate and very negative interest rate differentials implies a significant headwind to the returns to be earned on international investments. If Japanese investors make similar judgements to those implied by our Capital Market Assumptions, this may cause them to reassess the size of their allocations to international investments given the potential for currency impacts to weigh on returns.

Figure 10: Japanese and international return forecasts in Japanese yen

Source: Ninety One, Bloomberg, 31 March 2024.

This is a particularly important consideration because Japan is the world’s largest net creditor with net foreign assets in excess of U$3.4 trillion as at the end of 2023². To put this figure in perspective, the market capitalisation of the entire Japanese equity market on this date was US$6.2 trillion³. Relatively small reallocations of capital by Japanese investors therefore have the potential to impact relative prices to a significant degree.

Figure 11: Net international investment position of largest net creditors and debtors⁴

Source: Ninety One, Bloomberg, 31 March 2024.

The historic evolution of Japan’s net foreign investment position demonstrates the link between the net international investment position and currency returns. Japan began the process of liberalising capital markets and removing capital controls from 1967 following admission to the Organisation for Economic Co-operation and Development (OECD). Throughout the 1970s and 1980s the Japanese economy boomed, capital flowed into the country and the Japanese yen appreciated substantially. During this period, the net international investment position remained relatively stable and close to neutral.

A very different dynamic emerged from the 1990s onward following the bursting of the Japanese asset bubble. As economic growth stagnated and deflation took hold, monetary policy proved largely ineffective at reversing these trends but did contribute to structural currency depreciation. Alongside this, portfolio inflows slowed and Japanese investors and corporates increasingly sought to diversify across international markets. As a result, the net international investment position grew steadily throughout this era, leading to the current juncture where Japan has accumulated net ownership of overseas assets worth in excess of 80% of Japanese GDP as at 31 December 2023.

Figure 12: Japan net international investment position as % of GDP

Source: Ninety One, Bloomberg, 31 March 2024.

Japanese investors have benefitted significantly from this growth in the value of their international investments, but our Capital Market Assumptions imply that, over the medium term, these exposures are facing a substantial currency headwind. It therefore seems likely that these historic trends fade or reverse over time, with policy convergence, reduced capital outflows and lower returns on international investments combining to drive Japanese yen appreciation and an adjustment in Japan’s net international investment position.

² Source: IMF, as at 31 December 2023. Note that this total includes direct investment and reserve assets as well as portfolio investments. The economic rationales behind these different categories of investment vary significantly whilst the analysis set out here relates most directly to portfolio investments.
³ Source: Bloomberg, as at 31 December 2023.
⁴ Source: IMF, as at 31 December 2023 or latest available.

Prospective global equity returns have reduced over the last six months in local currency terms as most markets continued to rally. Within developed markets, the UK offers higher expected returns than other developed regions, while emerging markets offer a significant return uplift compared to developed markets.

Figure 13: Equity: 10 year local currency return forecast

Performance does not guarantee future results. Actual returns could be materially higher or lower than projected.

Source: Ninety One (internal calculations based on Bloomberg data).

Prospective returns have decreased across the board as risk assets have continued to rally, bar China. China’s devaluation sees it among a handful of markets whose revaluation return is expected to be positive over the next decade. Emerging markets in aggregate look overvalued, as do most developed markets; however Asia ex Japan seems fairly valued.

The US, led by the ‘Magnificent Seven’, has continued to reprice – making it even more expensive since our last update, when we were already expecting a downward revaluation over the next decade. Returns on developed market equities therefore look unusually small; in fact, the forecast (in USD hedged terms) for global equities as a whole would be among the lowest 10-year rolling outcomes over the last few decades.

Figure 14: Growth dominates return expectations, with revaluation almost uniformly negative

Performance does not guarantee future results. Actual returns could be materially higher or lower than projected.

Source: Ninety One (internal calculations based on Bloomberg data). Estimates are nominal, gross of fees and ignore alpha. The final total returns are converted from logarithmic to geometric estimates. This means that the components of the return breakdown may not sum to the total return. Judgmental overrides may apply where deemed necessary – for example as currently applied to the UK assumption to account for the region’s current dividend yield which is in our view structurally out-of-kilter both with its own history, and that of peers. Modelling involves risks, assumptions and uncertainties. These estimates reflect the view of Ninety One’s Multi-Asset team, while the views of other teams across Ninety One may differ.
For information on our Capital Markets Assumptions methodology, please see Important information. Return breakdowns in local currency.

To give a further understanding of the relative attractiveness of prospective returns across equity markets, it is helpful to consider our return forecasts in the context of the historic range of outcomes for each market.

Figure 15: Historic returns

Source: Ninety One proprietary Capital Market Assumptions as at 31 March 2024. Estimates are nominal, hedged into USD, gross of fees and ignore alpha. Modelling involves risks, assumptions and uncertainties. These estimates reflect the view of Ninety One’s multi-asset team, while the views of other teams across Ninety One may differ. Performance does not guarantee future results. Actual returns could be materially higher or lower than projected. For information on our Capital Markets Assumptions methodology, please see Important information.

• The chart above shows the distribution of historic 10-year rolling geometric returns, hedged into USD, for the assets (in the box-and-whisker plot) versus the current forecast (yellow bar).
• The body of the box represents the interquartile range, while the ‘whiskers’ extend to the maximum and minimum historic rolling 10-year returns.
• While forecast equity returns do not generally look attractive in an absolute sense, the US and Europe are comfortably in the lowest quartile versus their recent history. China stands out on this basis; it both approaches the upper quartile of recent outcomes and has attractive absolute returns.

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

Figure 16: Equity expectations

Source: Ninety One (internal calculations based on Bloomberg data).

Figure 17: Fixed income expectations

Source: Ninety One (internal calculations based on Bloomberg data).
EMBI = Emerging Markets Bond Index; CEMBI = Corporate Emerging Markets Bond Index; EMLC = Emerging Market Local Currency

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:

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:

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 judgmental adjustments to the underlying drivers if warranted.

Our approach mimics that of a systematic investor, buying the entire market.

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

⁵ 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.
⁶ 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.
⁷ Yield to Maturity based on notional 10-year bonds (except in the case of High Yield and EM Corporate, where 5-year bonds are used). For EM Hard Currency, US High Yield and EM Corporate, we use the underlying risk-free curve plus spread-to-worst to construct the initial yield.
⁸ Credit spread curve data tends to be unreliable; we presume because the notion of quality changes with tenor. We therefore assume a constant spread.
⁹ This is an implicit allowance for rebalancing of the constant maturity bond.
¹⁰ 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, and the information is publicly disclosed – 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.

Figure 18: 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 in the next chart. 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 locally¹¹. Growth is proxied based on trailing 15-year trend growth, a period that captures the secular effects of a couple of cycles. We apply a market adjustment factor – which includes changes in market composition relating to primary and secondary issuance, M&A activity, buybacks, new index inclusions etc. In each case, an owner of the market would have to either inject or remove capital to remain fully invested.

Figure 19: Nominal GDP per capita has proved a useful proxy for dividend growth

Source: Shiller, U.S. Stock Markets 1871-Present and CAPE Ratio; Samuel H. Williamson, “What was the US GDP Then?” MeasuringWorth, 2022.

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 Figure 20.

Figure 20: 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 market inclusions, as illustrated below.

Figure 21: Regional indices are generated using a weighted average of the relevant countries

Source: Ninety One calculations. Weights based on JP Morgan 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).

Figure 22: Growth is the roll yield from consistently rebalancing the portfolio to maintain a constant maturity

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 even though 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 focused whereas listed companies often have substantial global operations.

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. (Based on history, we have applied an additional default factor for sub investment grade sovereign debt).

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 Capital Market Assumptions 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 understand 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.

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. 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 plus 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 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 COVID-induced market collapse.

Q What is an index divisor and what causes this value to change?

The index divisor is defined as:

Index divisor = Index market cap/Index price

The index divisor is central to the calculation of equity indices because there are corporate actions and compositional changes which affect the aggregate value or market capitalisation measured by the index, but which do not impact the performance of the index. When the market value of the index increases or decreases because of one of these events, the index divisor is adjusted to ensure that the price of the index remains unchanged.

The impact of specific corporate actions or compositional changes can be either positive or negative for future returns, but they are aggregated into a single overall value.

A non-exhaustive list of some of the corporate actions which impact the index divisor is given in the table below.

In addition, the composition of the index can change as a result of index rebalancing events where index rules determine that existing companies be added to or removed from an index or that the proportion of a company’s shares which are included in the index changes. For regional indices, whole countries may also be added or removed from the index.

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 market adjustment impact from the change in MSCI Index Divisor over time.

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

Broad economic growth drives the growth generated by the listed corporate sector over the long run. However, it is accepted that corporate action, including mergers, acquisitions, research, and innovation ensure that the corporate sector is dynamic, undergoing compositional changes over time.

Our process starts with an assessment of the aggregate growth of the dividends paid by this dynamic mix of businesses. The next step is to make a market adjustment to capture all the corporate actions and index composition changes which directly increase or decrease the total value of equity measured by the market index.

As defined, the market adjustment factor is important as it changes the participation in the aggregate dividend growth of the entire market for an ongoing investor in the index. Market adjustments at the index level are analogous to but not identical to the way that equity issuance and repurchases affect returns for a single stock. To understand this, we must first recognise that to receive the index return, an investor must build a portfolio which holds every stock in the index in their index weights and which adjusts these holdings over time as index composition and weights change.

Any corporate action or index composition change which adds new equity capital into the index therefore dilutes future index returns in the same way that a company making a rights issue dilutes returns for holders of that stock. In both cases, if an investor does nothing, their ownership of the index or of the stock declines and the proportion of future value creation which flows to their shares falls. On the flipside, any corporate action or index composition change which removes equity capital from the index is accretive to future returns in the same way that a company repurchasing and retiring existing shares is accretive.

Importantly, these effects only directly impact an investor who seeks to own the entire market as defined by the index provider. For an active investor who does not hold the companies which launch these corporate actions there is no direct impact on their returns although there may be indirect impacts because of related capital flows or changes in the competitive environment.

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 in this analysis, 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 shareholders, are less subject to manipulation than 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 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 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, despite cyclical noise.