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2016 Capital Market Projections Each year, Callan develops long-term capital market projections, detailing expected return, standard deviation, and correlations for major asset classes. These projections are the cornerstone for strategic planning. This charticle summarizes key figures from Callan’s 2016 capital market projections. Callan’s 10-Year Expectations 10-Year Return and Risk Projections Projected Return (standard deviation) Small/Mid Cap Global ex-U.S. Equity 7.6% Developed Non-U.S. Equity 7.3% Emerging Market Equity 7.6% support nominal returns. U.S. Fixed Income 3.0%: We expect interest rates to rise, especially if the economy continues to expand and the Fed executes on its stated monetary policy. Bonds will suffer capital losses before 27.9% higher yields kick in. We expect 10-year Treasury 3.8% sion to mean, but lower than 20 11.4% 9.2% 9.9% 6.0% the long run average. 15 Number of Years 10.5% 4.6% 2015 2011 2007 10 5.3% Hedge Funds 2014 2012 2010 2006 Inflation 2.3% 1.5% downward pressure on income returns at 4%-5% with 2013 vestment. 5 0 Hedge Funds 5.3%: Steady relative to last year (T-bills 2008 -50%– -40%– -30%– -20%– -10%– 0%– -40% -30% -20% -10% 0% 10% 10%– 20% 20%– 30%– 30% 40% 40%– 50% Over 50% plus 3%). Source: Standard & Poor’s Interest Rates Expected to Rise From Historic Lows 32.8% 12% Federal Funds 10-year Treasury 30-year mortgage BAA corporate Projected 9.3% 10% 18.5% 2.3% 0.9% 2009 16.5% 2.8% Cash Equivalents Real Estate 6.0%: Reflects increased competition for in- 8.2% Private Equity ten-year projection—a rever- 88 Years of Stock Market Returns 1.4% Real Estate growth is falling but still high; inflation expectations yields to reach 3.3% over the 5.0% Emerging Market Debt late into equity returns. Emerging market economic 20.1% 3.0% 5.3% Non-U.S. Fixed non-U.S. market economic performance will trans- 21.3% 3.7% High Yield Global ex-U.S. Equity 7.6%: Improved developed 22.8% 2.6% Short Duration 2.3% Long Duration besides dividends. 18.0% 7.6% 3.0% something more from the return on free cash flow, 18.7% 7.3% Large Cap Commodities muted, fundamentals remain reasonable. Expect 7.4% Broad U.S. Equity TIPS in 2015. While the U.S. economic outlook is more Projected Risk (10-year geometric) U.S. Fixed U.S. Equity 7.4%: U.S. markets went sideways 8% 6% 4% 2% Source: Callan 0% 1990 Projected Risk and Return of Different Asset Mixes 1995 2000 2005 2010 This exhibit uses Callan’s projections to create a range of efficient portfolios on a spectrum from conservative to aggressive. Private Equity Hedge Funds 14.8% 11.0% 9.2% 7.4% 5.2% 3% 7% 5% 6% 4% 8% 7% 6% 54% 44% U.S. Fixed Income Global ex-U.S. Equity Broad U.S. Equity Source: Callan 11% 14% <<< Conservative 14% 17% 6.9% 6.5% 6.1% 5.7% 5% 8% 8% 5% Real Estate High Yield 2018 12.8% 10-year projected return 10-year projected standard deviation 2015 Source: IHS Inc. 35% 17% 22% Moderate 6% 9% 7% 9% 10% 5% 11% 25% 20% 25% 5% 15% 24% 29% Aggressive >>> About These Projections Callan’s projections consist of three primary figures for each asset class: a mean rate Multiple elements of the capital markets influence the projections: returns relative of return, a corresponding range defined by standard deviation, and the correlations to to inflation, equity valuations, risk premiums, GDP growth, and many other factors. other asset classes. These figures represent our best thinking for long-term expecta- These projections incorporate advanced quantitative modeling as well as qualitative tions and establish a mid-point within a wider range of potential outcomes. We use the feedback and the economic expertise of Callan’s consulting professionals. Our 2016 projections to model portfolios for our clients. numbers reflect our optimism for the economy, for inflation, and for the capital markets. Correlation Expectations (10 Years) Relationships between asset classes are as important as standard deviations. In the past, particularly in stressed Broad U.S. Equity 1.000 Large Cap 0.997 1.000 Small/Mid Cap 0.965 0.940 1.000 Global ex-U.S. Equity 0.882 0.879 0.853 1.000 Dev. Non-U.S. Equity 0.852 0.850 0.820 0.986 1.000 Emerging Market Equity 0.861 0.855 0.840 0.933 0.860 1.000 Short Duration -0.240 -0.230 -0.260 -0.254 -0.230 -0.280 1.000 U.S. Fixed -0.108 -0.100 -0.130 -0.123 -0.105 -0.150 0.870 1.000 0.136 0.138 0.121 0.106 0.119 0.069 0.729 0.925 1.000 TIPS -0.050 -0.045 -0.065 -0.053 -0.045 -0.065 0.530 0.580 0.527 1.000 High Yield 0.640 0.640 0.610 0.629 0.610 0.610 -0.170 0.020 0.220 0.060 1.000 Non-U.S. Fixed 0.014 0.050 -0.100 0.013 0.060 -0.090 0.480 0.510 0.542 0.340 0.120 1.000 Emerging Market Debt 0.579 0.580 0.550 0.550 0.530 0.540 -0.120 0.030 0.159 0.150 0.600 0.010 1.000 Real Estate 0.735 0.730 0.715 0.669 0.650 0.645 -0.140 -0.020 0.190 0.005 0.560 -0.050 0.450 1.000 Private Equity 0.948 0.945 0.915 0.934 0.905 0.905 -0.240 -0.190 0.062 -0.100 0.640 -0.060 0.560 0.710 1.000 Hedge Funds 0.797 0.795 0.765 0.760 0.735 0.740 -0.120 0.080 0.303 0.055 0.570 -0.080 0.540 0.600 0.770 1.000 Commodities 0.167 0.165 0.165 0.177 0.170 0.175 -0.220 -0.120 -0.042 0.100 0.100 0.050 0.190 0.200 0.180 0.210 1.000 Cash Equivalents -0.043 -0.030 -0.080 -0.040 -0.010 -0.100 0.300 0.100 -0.049 0.070 -0.110 -0.090 -0.070 -0.060 0.000 -0.070 0.070 1.000 Inflation -0.020 0.020 0.010 0.000 0.030 -0.200 -0.280 -0.284 0.180 0.070 -0.150 0.000 0.100 0.000 0.200 0.400 0.000 1.000 Global ex-U.S. Dev. Non-U.S. EM Equity Short Duration U.S. Fixed Long Duration TIPS High Yield Non-U.S. Fixed EM Debt Real Estate Private Equity Hedge Funds Comm. Cash Equiv. Inflation Long Duration Source: Callan -0.011 markets, correlations between asset classes have risen. Broad Large Cap Sm/Mid Cap Callan revisits and adjusts our correlation expectations annually. Among the risky asset classes, correlations are high and will remain high. Interestingly, stocks and bonds have exhibited tremendous negative correlation over time. Other uncorrelated asset classes have been commodities, TIPS, and to some extent many absolute return strategies. We believe real estate will maintain a diversification benefit, but it is harder to measure given the valuation process. Then and Now: Comparing Historical Returns to Historical Projections Annualized Returns How Callan’s 10-Year Return Projections Have Changed Since 1996 10 Years 15 Years 25 Years 7.35% 5.39% 10.03% 7.31% 5.00% 9.82% 7.56% 8.08% 11.72% MSCI World ex USA 2.92% 3.58% 5.47% MSCI Emerging Markets 3.95% 8.87% 8.63% Barclays Aggregate 4.51% 4.97% 6.15% Barclays Glbl Agg. ex-USD 3.10% 4.59% 4.59% Barclays Long Gov/Credit 6.45% 7.07% 5.37% Broad U.S. Stock Market Russell 3000 Large Cap U.S. Stocks S&P 500 Small/Mid Cap U.S. Stocks Russell 2500 Non-U.S. Stock Markets Fixed Income 7.77% 8.97% 8.05% 4.97% 5.95% – U.S. fixed income Non-U.S. fixed income Cash equivalents Real estate Inflation (CPI-U) 15% 12% 9% 6% 3% 0% Real Estate NCREIF Broad U.S. equity Non-U.S. equity Private equity Projected 10-Year Return for periods ended 12/31/2015 96 98 00 02 Source: Callan 04 06 08 10 12 14 16 Year Hedge Funds Credit Suisse Hedge Fund Founded in 1973, Callan Associates Inc. is one of the largest independently owned Private Equity Cambridge Private Equity* 11.80%* 7.51%* 15.74%* -7.49% -2.49% – 1.24% 1.61% 2.93% Inflation CPI-U** firm provides research, education, decision support, and advice to a broad array of For more information, please contact your Callan consultant. San Francisco | 800.227.3288 Cash Market 90-Day T-Bill investment consulting firms in the country. Headquartered in San Francisco, CA, the institutional investors. Commodities Bloomberg Commodity About Callan 1.91% 1.95% 2.30% * Private equity data is time-weighted return series for periods ended 9/30/2015 rather than 12/31/2015 due to a reporting lag. ** CPI-U data are measured as year-over-year change through 12/31/2015. Sources: Barclays, Bloomberg, Bureau of Labor Statistics, Callan, Cambridge, Credit Suisse, MSCI, NCREIF, Russell, and Standard & Poor’s. Atlanta | 800.522.9782 Published February 2016 Chicago | 800.999.3536 © 2016 Callan Associates Inc. Denver | 855.864.3377 New Jersey | 800.274.5878 This report is for informational purposes only and should not be construed as legal or tax advice on any matter. Any investment decision you make on www.callan.com the basis of this report is your sole responsibility. Investing has Become More Complex …Risk is a Constant This chart articulates the asset mix and associated risk needed in order to achieve an expected 7.5% return at different points in history. ● Over time, achieving a 7.5% return has necessitated the assumption of three times the risk (standard deviation) ● Reality is that investors have had to make a key decision – reduce return expectations or increase risk ● There is no “free lunch” ● New asset classes and strategies have allowed asset owners to diversify into increasingly smaller slices, but each “slice” of the allocation pie chart requires its own expert monitoring and measuring ● Diversification is helpful, but investors must be aware whether diversification is actually improving returns or is simply another “risk” in disguise Source: Callan Associates