In developing long-term investment strategies, investors conduct Strategic Asset Allocation (SAA) work to follow the portfolio that best balances risk and return. SAA relies on consistent forecasts পু capital market forecasts, for example উপর on long-term investment expectations and volatility. Such predictions are usually presented in the expected return, volatility, and interval value-interval framework:
- Expected return: Average annual income on the long-distance horizon
- Instability: The deviation of the value of the annual return
- Correlation: How closely related returns of different investments
Investors have come to rely on JPMorgan’s long-term capital market estimates (LTCMA) to determine the distribution of strategic assets used to build the best portfolio. JPMorgan’s team of more than 50 economists and analysts revised the annual forecast to include new data from markets, policymakers and the economy.
For 2021, JPMorgan predicts efforts to abstain from short-term challenges and consider the lasting consequences of the Covid-1 crisis, in particular, the implications of policy responses to epidemics. Surprisingly, JPMorgan expects “very little” long-term consequences for global economic activity. In fact, its growth forecasts were similar to those of Pre-Covid.
“Aligning monetary and monetary policy in the same helpful direction is probably the biggest single difference between the structure of the economy between this new cycle and the end.” – JP Morgan
For the United States, JPMorgan expects equity market returns to fall to 4.1% in the next 10 to 15 years from 5.6% last year. This reduction largely reflects the effect of assessment normalization. For fixed income, JPMorgan’s forecast predicts three steps for government bonds: a two-year stable return, then a three-year capital devaluation, and a return to equity. As a result, the 10-year Treasury expected earnings fell from 2.76% to 1.54%. And, with a healthy and well-capitalized banking sector, JPMorgan believes the current cycle is less likely to create a credit-disrupted crisis, especially with existing US Federal Reserve support.
Across the investment horizon, JPMorgan sees moderate economic growth and limited returns in many asset classes. Nonetheless, it is optimistic that, through glossy and precise portfolio action, investors can collect an acceptable return without an unacceptable increase in portfolio risk.
With this in mind, investors should compare the optimized portfolios presented here with their existing allocations and their own personal market perspective and reconcile accordingly.
With the Portfolio Visualizer Online Suite of Portfolio Analysis Tools, I have created an “efficient frontier” of portfolios based on JP Morgan 2021 LTCMA for eight canonical resource classes and their respective vanguard tickers:
- US Interim Treasury (VFITX)
- US Investment Grade Corporate Bonds (VWESX)
- US High Yield Bonds (VWEHX)
- Emerging market sovereign debt (VGAVX)
- U.S. Large-Cap Equity (VFINX)
- US Small-Cap Equity (VSMX)
- EAFE Equity (VTMGX)
- Emerging Market Equity (VEMAX)
An efficient border finds the expected returns from an optimized portfolio, or those that provide the highest expected returns in a range of risk points. I create a portfolio with the highest sharp ratio, which is defined as the expected return of additional portfolio on the volatility of the portfolio.
Four optimal portfolios were found using JPMorgan’s LTCMA and Portfolio Visualizer’s efficient Frontier tools:
- Maximum sharp ratio: Maximize the sharp ratio
- Conservative risk: 35% / 65% match the volatility of the stock-bond portfolio
- Moderate risk: 65% / 35% match the volatility of the stock-bond portfolio
- Offensive risk: 100% match the volatility of the stock portfolio
The long-term capital market estimates for the eight canonical asset classes are as follows:
Long-term capital market estimates
Source: JP Morgan
I have used historical relations between the eight resource classes.
Asset allocation for the four optimal portfolios is as follows:
Source: Anson J. Glassy, Jr., CFA
These results show that an investor with moderate risk can expect an average return of 6.25% over the next 10 to 15 years.
The most interesting thing is the absence of domestic large-cap and small-cap equity and investment-grade bonds among the four favorable portfolios. This is due to the significant progress raised by the normalization of valuations: In the United States, long-term cycles after long-term performance of the stock market are not uncommon.
The diversified role that intermediate treasuries play in low-risk portfolios is also significant. The portfolio visualizer applies a -0.16 correlation between treasury and large-cap equity. A “balanced” portfolio for high-risk investors, by contrast, has US-non-equity with sovereign debt. JPMorgan’s forecast suggests that such a portfolio could yield an average return of more than 7.5% in the long run. For example, an aggressive portfolio matches the S&P 500 at risk but improves expected earnings by about 2.5 percentage points!
The Max Sharp Ratio portfolio displays a sharp ratio of 0.88 but gives the expected return which may not be enough for some investors. The other three portfolios have a sharp ratio between 0.515 and 0.675.
These bread-and-butter portfolios belong to the main public asset class which are mostly building blocks of mutual funds and exchange-traded funds (ETFs). Alternative assets, such as hedge funds and products, are not included. JPMorgan’s view is that interest rates will remain “low for a longer period of time” and that opportunities for alpha, income and diversity in traditional endowment assets will shrink. This may make the options a mandatory offer as they show less correlation with traditional therapeutic assets and may provide higher returns.
These favorable portfolios are suitable for long-term investors of various risky companies who measure risk through return variability. Investors using other risk measures – for example, sortino, minimal downdraft – can see different results.
Even as equity markets have moved closer to all-time highs and low yields of bond yields, it is still possible to build resilient portfolios with reasonable return expectations. Thoughtful investors may consider creating their long-range asset allocation around these favorable portfolios.
If you liked this post, be sure to subscribe Entrepreneurial investors.
All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.
Image Credit: © Getty Images / cosmin4000
Professional education for CFA Institute members
Members of the CFA Institute have the ability to earn self-assessment and self-reporting professional education (PL) credit, including content Entrepreneurial investors. Members can easily record credit using their online PL tracker.