Download Long-Term Capital Market Assumptions

FOR INSTITUTIONAL, PROFESSIONAL, WHOLESALE AND QUALIFIED INVESTORS/CLIENTS ONLY; NOT FOR RETAIL CLIENTS
CAPITAL MARKET ASSUMPTIONS• APRIL 2017
BlackRock’s methodology for
long-term returns
What investment returns can we expect in the long term across asset classes? Such
assumptions are a key input of asset allocation decisions for institutions, financial
advisors and individual retirees. This document presents the methodology used to
calculate the BlackRock Investment Institute’s long-term equilibrium capital market
assumptions (CMAs), the long-term complement to our five-year CMAs.
We publish our return assumptions in an interactive graphic. The tool enables clients
to visualize expected returns, volatilities and correlations of fixed income, equity and
alternative assets – from several different currency perspectives.
Alain Kerneis
Head of Strategy and Market
Views, BlackRock Client Solutions
Our long-term equilibrium assumptions reflect “equilibrium” or “valuation-neutral”
market conditions that we would expect in the long run, and can be used as key
inputs for strategic asset allocation. Our five-year assumptions incorporate valuation
signals and can help investors adjust their allocations when valuations and
macroeconomic conditions substantially deviate from equilibrium levels. We update
our assumptions quarterly, with the most significant changes occurring in the five-year
numbers.
The assumptions are formulated and published by the BlackRock Investment Institute
every quarter, guided by a team of BlackRock investment professionals with expertise
in portfolio management, economics, asset allocation and risk management.
Long-term model
Gabriella Barschdorff
Natalie Gill
Stuart Jarvis
Vivek Paul
BlackRock Client Solutions
contributors (top left to bottom right)
Our long-term assumptions are based upon a multi-factor model of asset prices,
known as the Arbitrage Pricing Theory (APT) in the finance literature. According to
this model, the return expected from an asset is the direct result of the asset’s
exposure to underlying sources of rewarded risk (“factors”) within investment markets.
The exposure of an asset to each underlying factor is the “beta” to that factor. The
expected return of an asset in excess of the risk-free rate is then just the sum of the
betas multiplied by the risk premium associated with each rewarded risk factor.
Our estimate of the risk-free rate is based upon current market expectations. The key
rewarded risk factors in our model are as follows
1.
Equities
2.
Interest rates
3.
Inflation
4.
Credit
5.
Illiquidity
We describe these factors in more detail in the pages that follow.
20170425-147975-400999
FOR INSTITUTIONAL, PROFESSIONAL, WHOLESALE AND QUALIFIED INVESTORS/CLIENTS ONLY; NOT FOR RETAIL CLIENTS
A century of returns
Annual real returns: equity, bonds and cash, 1900-2016
Fixed income risk premia
We use risk premia relative to cash for longer duration fixed
income, inflation-linked bonds and credit. This is because
there is additional return associated with investing in longer
maturities, and with moving away from government bonds
into asset classes with credit risk, historical analysis
suggests.
The historical term premium (expressed as percentage
points of extra return per year of duration) of the sovereign
debt of G7 countries varies significantly over time, and has
dwindled to near zero in recent years. It has had a median
value of around 0.1 percentage points since 1987. See the
chart below. This is also consistent with the small premium
that global bonds delivered relative to cash between 1900
and 2016, as shown in the chart on the left.
Using the median value above, we would expect a 10-year
government bond to have a 0.5% higher yield than a fiveyear government bond.
Sources: BlackRock Investment Institute and Credit Suisse, April 2017. Notes:
Global equity and bond returns are Credit Suisse 23-country world indexes, with
the equity index weighted by market capitalization, and the bond index weighted by
GDP. Cash is represented by U.S. Treasury bills. Real returns are measured
relative to U.S. inflation. Data are as of end December 2016. Past performance is
not a reliable indicator of future performance.
Our research also suggests a lower term premium for
inflation-linked bonds (around 0.05 percentage points per
year of duration) – and a higher one for corporate credit
(around 0.25 percentage points).
Note: These numbers also can fluctuate over time and
depend on the risks of these different asset classes.
Equity risk premium
Term premium pendulum
The equity risk premium (ERP) represents the long-run
expected return advantage of holding equity over cash.
Term premium for G7 sovereign debt, 1987-2017
The observed annual ERP was 4.3% from 1900 to 2016, in
geometric terms (the difference between a historical equity
real return of 5.1% and cash returns of 0.8%). See the chart
above. The ERP has been a little higher than this over the
past five decades (see the bars for 1967-2016), but has
collapsed since 2000 due to historically muted equity
returns. We assume an ERP of 4.0% in the future, which is
slightly lower than what the 1900-2016 average would
suggest. Investors are better equipped with tools to
construct globally diversified portfolios than they were 100
years ago. Therefore, the compensation for market risk
should, in our view, be lower.
We extend this analysis to other asset classes by
accounting for their beta – a measure of how much an asset
or security tends to move along with an index or a portfolio.
For example, a beta of 0.75 between a stock and an index
indicates that for every 1% move in the index, the stock
would be expected to move by 0.75%.
We employ a multi-factor framework. This means the overall
risk premium of an asset depends on its beta to the
economic risk factor and its betas to the other risk factors
listed on the previous page. We add a cash return of 2% –
our estimate of the long-term risk free rate. After rounding
and adjusting the figures for annualizing, we arrive at a total
expected return.
Sources: BlackRock Investment Institute, April 2017.
Notes: The chart is based on the Bloomberg Barclays G7 Global Treasury Index.
The term premium is defined as the index yield minus the one-month U.S. cash
rate divided by the index duration. The median term premium is calculated over the
period shown.
2
20170425-147975-400999
FOR INSTITUTIONAL, PROFESSIONAL, WHOLESALE AND QUALIFIED INVESTORS/CLIENTS ONLY; NOT FOR RETAIL CLIENTS
Private-public market spreads
Alternative premia estimates
Forming return assumptions for alternative asset classes is
challenging. Reliable benchmarks for underlying asset class
returns are not always available in sectors such as
infrastructure and private equity.
To overcome these hurdles, we start with the same multifactor model as described on page 1 to form our
assumptions for a public market proxy. We then adjust our
assumptions to incorporate a few differences between
private and public markets, such as the higher levels of
leverage and fees that tend to be associated with private
markets. Investors’ expectations for being compensated for
illiquidity risk and any differences in valuation or supply and
demand between markets can also affect future
performance.
We estimate these factors from the historical performance of
private investments relative to public market equivalents,
again net of fees and adjusted for differences in leverage.
Given data limitations, we do not intend to produce estimates
for each of these factors individually and have defined an
aggregate measure of what we call the private-public market
spread.
Following are explanations of how we arrive at this spread
for the main alternative asset classes in our model portfolio:
Private Equity: The private equity risk estimates are
intended to relate to a representative exposure of a globally
diversified private equity fund-of-fund. Exposures to broad
risk factors (such as geography and sector) are based off our
analysis of the universe of private transactions in the private
equity market from 2000 to present. The private equity risk
estimates are constructed from estimated fund-of-fund
exposures, and assume a 25% / 75% allocation between
venture capital (VC) and leveraged buyouts (LBO).
Infrastructure Equity: For a diverse mix of infrastructure
equity assets, we believe a spread of 1% reflects a
reasonable extra return above that of an equivalent public
equity investment. This reflects the compensation investors
can expect to receive in exchange for accepting long lock-up
periods and idiosyncratic risks unique to private
infrastructure, such as regulation or construction risks.
Infrastructure Debt: Spreads on infrastructure debt in
recent years have contracted meaningfully, driven by
increased interest from institutional investors and a limited
supply of assets. Given the supply-demand picture, and the
fact that debt sits above equity in the capital structure,
investors should expect a smaller spread for infrastructure
debt compared to infrastructure equity or private equity. We
assume an illiquidity premium of 0.1%, based on our
analysis of the spread between private infrastructure debt
issues and liquid corporate bonds of equivalent credit quality.
Sources: BlackRock Investment Institute, December 2016. Notes: Estimates are
based on the historical annual performance of private investments relative to public
market equivalents, net of asset management fees and adjusted for differences in
leverage.
Private Real Estate and Mezzanine Debt: We do not
assign a spread to private real estate. This is because listed
and private (or direct) real estate have had similar returns
over the past two decades, according to NCREIF (private)
and NAREIT (public) index returns. We also find private and
public real estate to be exposed to similar return drivers. This
does not mean we believe private real estate is a poorly
rewarded asset class – it can still be attractive relative to
listed real estate for investors looking to shape a diversified
real estate portfolio, in our view. By contrast, we assume a
1% spread for real estate mezzanine debt. Increased
regulations are encouraging banks to curb lending. This
creates opportunities in mezzanine debt financing for
investors comfortable with concentrated exposures and long
lock-up periods, we believe. Our assumed spread for
alternative asset classes are summarized in the table above.
Alternatives calculations
In our framework, we explicitly focus on the returns and risks
associated with broad asset classes, (represented by an
index), as opposed to the risks and returns from investing in
any particular actively managed strategy. In alternatives, the
distinction between active (alpha) and passive (beta) is less
relevant, as there is usually no way to access beta on a
standalone basis. Indeed, a major motivation for allocating to
private markets is to find idiosyncratic sources of return that
can only be captured via skillful active management.
Given the difficulty of isolating an index return in alternatives
markets, the return numbers for alternatives in our capital
market assumptions are meant to represent the performance
of an average manager in those asset classes, net of fees.
Assumed returns for other asset classes are in index terms,
and, unless otherwise noted, returns not denominated in US
dollars are assumed to be currency unhedged.
3
20170425-147975-400999
FOR INSTITUTIONAL, PROFESSIONAL, WHOLESALE AND QUALIFIED INVESTORS/CLIENTS ONLY; NOT FOR RETAIL CLIENTS
Final calculations
In summary, the CMAs are based on the following:
•
Five rewarded risk factors;
•
the interrelationship between different asset
classes;
•
inherent return drivers such as compensation for
illiquidity and credit risk.
The resulting annualized risk premium assumptions for the
asset classes we track are displayed in the chart below. To
arrive at our final capital market assumptions, we add our
calculated estimates of the risk premium for each asset
class to the risk-free rate.
We then make adjustments for rounding and annualization.
For each asset class, we provide two sets of assumptions,
based on geometric and arithmetic calculations.
About the CMAs
The BlackRock Investment Institute (BII) formulates and
publishes CMAs every quarter. We cover long-term
equilibrium assumptions, which are key inputs for strategic
asset allocation, and five-year CMAs that take into account
how we think economic and market conditions play out in the
medium term.
This document assumes a US dollar currency perspective,
but our methodology is the same across regions and
currencies.
Our CMA group is responsible for formulating the
assumptions. It is co-chaired by BII’s Richard Turnill and
BlackRock Client Solutions’ Alain Kerneis and consists of
senior members from BII, BlackRock Client Solutions and
BlackRock’s Risk and Quantitative Analysis group.
See the appendix for an explanation of arithmetic versus
geometric returns, as well as for details on BlackRock
proxies for alternatives asset classes, where historical index
data are often lacking or of poor quality.
Beating cash
Expected long-term equilibrium annualized risk premiums over U.S. cash by asset class, December 2016
Sources: BlackRock Investment Institute, April 2017. Notes: The assumptions are based on geometric calculations. See our interactive graphic for full details on the return
assumptions and a list of the underlying indexes used for each asset class. Past performance is not a reliable indicator of future performance.
4
20170425-147975-400999
FOR INSTITUTIONAL, PROFESSIONAL, WHOLESALE AND QUALIFIED INVESTORS/CLIENTS ONLY; NOT FOR RETAIL CLIENTS
Appendix
Arithmetic returns in this document are converted into
geometric returns to account for volatility. A simplified
version of the formula we are using is:
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑔𝑒𝑜𝑚𝑒𝑡𝑟𝑖𝑐 𝑟𝑒𝑡𝑢𝑟𝑛
= 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑎𝑟𝑖𝑡ℎ𝑚𝑒𝑡𝑖𝑐 𝑟𝑒𝑡𝑢𝑟𝑛 − 0.5 × 𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑣𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦2
ALTERNATIVES PROXIES
Private equity: We use data (leverage, deal size,
geography, sector and type) on historical (venture and
buyout) deals for the time period from 2000 to the present.
This data is then mapped onto a variety of public market
factors, which are adjusted for private equity characteristics
including geography, industry, country, and leverage.
Infrastructure equity: We construct a proxy consisting of
exposures to baskets of publicly listed infrastructure-related
companies. We then adjust for unique characteristics of
private infrastructure investments, incorporating exposures
to construction and idiosyncratic, project-specific risks.
Private real estate: We seek to capture the true behavior of
global real estate across core, value-add and opportunistic
sectors, by analyzing publicly available market indices
(FTSE EPRA / NAREIT Global Real Estate Index series and
NCREIF Property Index NPI series) looking back several
years (1993 -2012). We use regression analysis to map
these publicly traded risk factors to the characteristics we are
seeking as representative of global real estate, including
property type, geography, leverage, and sector exposures.
Real estate mezzanine debt: This is modeled as a mix of
real estate and high yield, plus an adjustment to more
closely mirror the volatility and behavior of that asset class.
The correlations used in our calculations can be found in the
matrix below.
Seeking diversification
Assumed correlations between asset classes, December 2016
Sources: BlackRock Investment Institute, April 2017. Notes: The correlation and volatility forecasts are based on a proprietary BlackRock risk model, using monthly
returns since September 2000. See our interactive graphic for a list of underlying indexes used for each asset class.
5
20170425-147975-400999
BlackRock Investment Institute
BlackRock's Capital Market Assumptions disclosures: This information is not intended as a recommendation to invest in any particular asset class or strategy or as a
promise of future performance. Note that these asset class assumptions are passive, and do not consider the impact of active management. All estimates in this document
are in U.S. dollar terms unless noted otherwise. Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization
approaches in setting strategic allocations to all the asset classes and strategies. References to future returns are not promises or even estimates of actual returns a client
portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell
securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the
information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to
provide, and should not be relied on for, accounting, legal, or tax advice. The outputs of the assumptions are provided for illustration purposes only and are subject to
significant limitations. “Expected” return estimates are subject to uncertainty and error. Expected returns for each asset class can be conditional on economic scenarios; in
the event a particular scenario comes to pass, actual returns could be significantly higher or lower than forecasted. Because of the inherent limitations of all models, potential
investors should not rely exclusively on the model when making an investment decision. The model cannot account for the impact that economic, market, and other factors
may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual
trading, liquidity constraints, fees, expenses, taxes and other factors that could impact future returns; General Disclosures: This material is prepared by BlackRock and is
not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any
investment strategy. The opinions expressed are as of April 2017 and may change as subsequent conditions vary. The information and opinions contained in this material
are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. As
such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of
negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ‘forward-looking’ information that is not purely historical in nature. Such
information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this
material is at the sole discretion of the reader. This material is intended for information purposes only and does not constitute investment advice or an offer or solicitation to
purchase or sell in any securities, BlackRock funds or any investment strategy nor shall any securities be offered or sold to any person in any jurisdiction in which an offer,
solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. In the U.S., this material is intended for public distribution. In the EU issued by
BlackRock nvestment Management (UK) Limited (authorised and regulated by the Financial Conduct Authority). Registered office: 12 Throgmorton Avenue, London, EC2N
2DL. Registered in England No. 2020394. Tel: 020 7743 3000. For your protection, telephone calls are usually recorded. BlackRock is a trading name of BlackRock
Investment Management (UK) Limited. This material is for distribution to Professional Clients (as defined by the FCA Rules) and Qualified Investors and should not be relied
upon by any other persons. For qualified investors in Switzerland, this material shall be exclusively made available to, and directed at, qualified investors as defined in the
Swiss Collective Investment Schemes Act of 23 June 2006, as amended. This information can be distributed in and from the Dubai International Financial Centre (DIFC) by
BlackRock Advisors (UK) Limited - Dubai Branch which is regulated by the Dubai Financial Services Authority (“DFSA”) and is only directed at ‘Professional Clients’ and no
other person should rely upon the information contained within it. Neither the DFSA or any other authority or regulator located in the GCC or MENA region has approved this
information. Issued in the Netherlands by the Amsterdam branch office of BlackRock Investment Management (UK) Limited: Amstelplein 1, 1096 HA Amsterdam, Tel: 020 549 5200. For more information please see the website: www.blackrock.nl. Issued in Australia and New Zealand by BlackRock Investment Management (Australia) Limited
ABN 13 006 165 975 AFSL 230 523 (BIMAL) for the exclusive use of the recipient who warrants by receipt of this material that they are a wholesale client and not a retail
client as those terms are defined under the Australian Corporations Act 2001 (Cth) and the New Zealand Financial Advisers Act 2008 respectively. This material contains
general information only and does not constitute financial product advice. This material has been prepared without taking into account any person’s objectives, financial
situation or needs. Before making any investment decision based on this material, a person should assess whether the information is appropriate having regard to the
person’s objectives, financial situation and needs and consult their financial, tax, legal, accounting or other professional advisor about the information contained in this
material. This material is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local
law or regulation. BIMAL is the issuer of financial products and acts as an investment manager in Australia. BIMAL does not offer financial products to persons in New
Zealand who are retail investors (as that term is defined in the Financial Markets Conduct Act 2013 (FMCA)). This material does not constitute or relate to such an offer. To
the extent that this material does constitute or relate to such an offer of financial products, the offer is only made to, and capable of acceptance by, persons in New Zealand
who are wholesale investors (as that term is defined in the FMCA). BIMAL is a part of the global BlackRock Group which comprises of financial product issuers and
investment managers around the world. This material has not been prepared specifically for Australian or New Zealand investors. It may contain references to dollar amounts
which are not Australian or New Zealand dollars and may contain financial information which is not prepared in accordance with Australian or New Zealand law or practices.
BIMAL, its officers, employees and agents believe that the information in this material and the sources on which the information is based (which may be sourced from third
parties) are correct as at the date specified in this material. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given
and no responsibility for this information is accepted by BIMAL, its officers, employees or agents. Except where contrary to law, BIMAL excludes all liability for this
information. Past performance is not a reliable indicator of future performance. Investing involves risk including loss of principal. No guarantee as to the capital value of
investments nor future returns is made by BIMAL or any company in the BlackRock Group. For investors in Singapore: Issued by BlackRock (Singapore) Limited (Co.
registration no. 200010143N). This material is issued for Institutional Investors only (or professional/wholesale investors as such term may apply in local jurisdictions) and
does not constitute investment advice or an offer or solicitation to purchase or sell in any securities, BlackRock funds or any investment strategy nor shall any securities be
offered or sold to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. In Malaysia:
BlackRock does not hold any license or registration under the Capital Market and Services Act 2007 of Malaysia (“CMSA”) or other Malaysian legislation, nor does BlackRock
purport to carry on any regulated activity in Malaysia. Nothing in this document, directly or indirectly represents to you that BlackRock will provide, or is providing BlackRock
products or services to you in Malaysia. This material is intended solely for Sophisticated Investors as defined under Part I of Scheme 6 & 7 of CMSA. In Thailand, this
material is intended only for Institutional Investors (as such term is defined by Securities and Exchange Commission). In Brunei: The distribution of the information contained
herein may be restricted by law and persons who access it are required to comply with any such restrictions. The information provided herein information is directed solely at
persons who would be regarded as “Accredited Investors”, “Expert Investors” or “Institutional Investors” in accordance with the Securities Market Order 2013. In Hong Kong,
this material is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong. This
material is for distribution to ‘Professional Investors’ (as defined in the Securities and Futures Ordinance (Cap.571 of the laws of Hong Kong) and any rules made under that
ordinance) and should not be relied upon by any other persons or redistributed to retail clients in Hong Kong. In Korea, this material is for Professional Investors only. In
Japan, this is issued by BlackRock Japan. Co., Ltd. (Financial Instruments Business Operator: The Kanto Regional Financial Bureau. License No375, Association
Memberships: Japan Investment Advisers Association, The Investment Trusts Association, Japan, Japan Securities Dealers Association, Type II Financial Instruments Firms
Association.) for Professional Investors only (Professional Investor is defined in Financial Instruments and Exchange Act) and for information or educational purposes only,
and does not constitute investment advice or an offer or solicitation to purchase or sells in any securities or any investment strategies. In Taiwan, independently operated by
BlackRock Investment Management (Taiwan) Limited. Address: 28/F, No. 95, Tun Hwa South Road, Section 2, Taipei 106, Taiwan. Tel: (02)23261600. In Canada, this
material is intended for permitted clients only. In Latin America and Iberia, this material is for educational purposes only and does not constitute investment advice nor an
offer or solicitation to sell or a solicitation of an offer to buy any shares of any fund (nor shall any such shares be offered or sold to any person) in any jurisdiction in which an
offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. If any funds are mentioned or inferred to in this material, it is possible that
some or all of the funds have not been registered with the securities regulator of Brazil, Chile, Colombia, Mexico, Panama, Peru, Portugal, Spain, Uruguay or any other
securities regulator in any Latin American country and thus might not be publicly offered within any such country. The securities regulators of such countries have not
confirmed the accuracy of any information contained herein. The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for
specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to
foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks
are often heightened for investments in emerging/developing markets or smaller capital markets. ©2017 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered
trademark of BlackRock, Inc. All other trademarks are those of their respective owners.
20170425-147975-400999