10 Year Capital Market Assumptions for 2021

10-Year Capital Market Assumptions Calendar Year 2021 2 10-Year Capital Market Assumptions Overview On an annual basis, BNY Mellon Investor Solutions, LLC develops capital market return assumptions for approximately 50 asset classes around the world. The assumptions are based on a 10-year investment time horizon and are intended to guide investors in developing their long-term strategic asset allocations. Historically, the initial baseline assumptions were derived using consensus views, adjusted to reflect insights regarding global market imbalances based on research from across BNY Mellon. This year we have incorporated the macroeconomic forecasts generated by BNY Mellon Investment Management Global Economic and Investment Analysis Group, led by Chief Economist Shamik Dhar. Given the global pandemic and unprecedented amount of global monetary and fiscal stimulus deployed to support the economic recovery, we believe the incorporation of these probability-weighted forecasts will prove particularly useful given the high degree of coronavirus-related economic uncertainty. Overall, the results of our 2021 10-year capital market assumptions are mixed depending on the asset class when compared to last year’s assumptions (see Exhibit 1). We see stronger equity market returns due to higher growth rates as the economy recovers from the pandemic. Fixed income asset class returns will be extremely limited given how low global bond yields are today. Alternative asset class returns are mixed, with generally lower returns in absolute return or hedged strategies and amplified returns in private markets. Exhibit 1: Snapshot of Risk and Return for the 2021 Capital Market Assumptions 9% U.S. Private Equity US Private Equity EM Equity Equity 2021 Equity 2020 EM Equity 8% Fixed Income 2021 Fixed Income 2020 Alternatives 2021 Alternatives 2020 Int'lIntl Developed Equity Equity USU.S. Small Small Cap Cap Equity Equity 7% U.S.US Large Large Cap Equity 6% 5% 4% Hedge Funds Expected Returns Hedge Funds 3% EMEM Sovereign Sovereign Local Local CommoditiesCommodities U.S.US High High Yield Yield 2% USU.S. IG CreditIG Credit 1% U.S.US Treasury Treasury Bills Bills USU.S. Treasury Treasury GlobalGlobal Agg Agg Ex Ex-U.S.-US 0% 0% 5% 10% 15% 20% 25% Expected Risk (Standard Deviation) Source: BNY Mellon Investor Solutions. Data as of November 30, 2020. 3 10-Year Capital Market Assumptions Our capital market assumptions have implications for portfolio construction, centered on the importance of diversification and a shift away from the traditional 60% S&P 500 / 40% Bloomberg Barclays U.S. Aggregate portfolio. Though an equity portfolio focused on U.S. companies has experienced strong returns over the last 10 years, we believe a more diversified equity portfolio with additional emphasis on international markets will be beneficial. Over the long term, our view is that international equities will outperform U.S. equities due to a weaker U.S. dollar and more attractive valuation levels. Diversification of style and capitalization is also important as a rotation from growth to value and large to small cap may occur as the recovery from the pandemic broadens. It is no secret that fixed income returns around the world will be extremely challenged in the decade ahead given the historically low interest rate environment. We see many fixed income sectors returning near zero on a nominal basis and negative on a real basis. This calls into question the use of traditional fixed income as the risk anchor of a diversified portfolio. Going forward, we see a greater emphasis on non-traditional investments for risk mitigation such as absolute return, real return and hedged strategies. These strategies have the potential to generate positive real returns, provide downside protection to traditional equities and diversify against fixed income interest rate risk. Lastly, private markets deserve a greater focus over the next 10 years. The incremental return offered through private markets will be key to boost portfolio returns and offset the impact of historically low rates. With the opportunity set continuously shifting from public to private equity, an allocation to private markets is evolving from an option to a necessity in order to achieve long-term growth objectives. The remainder of the document outlines the assumptions in depth and provides supporting details behind the numbers. We hope you find the 2021 publication interesting and insightful. Economic Forecast Methodology Central to our building-block approach used for generating expected returns of major asset classes globally are our macroeconomic projections. Our long-term projections for GDP growth, inflation and short-term rates begin with three-year forecasts based on a range of outcomes developed by BNY Mellon Investment Management Chief Economist Shamik Dhar. We then assume as illustrated in Exhibit 2 that the building blocks gradually glide toward an equilibrium steady state based on long-term market consensus expectations. Our methodology allows us to generate expected returns under multiple macroeconomic scenarios and time horizons. Though our capital market assumptions are based on a 10-year horizon, the forecast period can be adjusted to generate returns over a shorter horizon, such as five years, or an ultra long-term horizon of 30 years or more. Exhibit 2: Historical and Projected U.S. Real GDP Illustration, 2019 Q4 = 100 Forecast of Chief History Economist Transition Period Equilibrium 125 120 115 110 105 100 95 90 85 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Source: BNY Mellon Investor Solutions, Vantage Point Q1 2021 4 10-Year Capital Market Assumptions Time-Tested Approach For decades, BNY Mellon has developed capital market return assumptions to guide our institutional and high net worth clients in structuring their long-term asset allocations. We continually look back and test our assumptions in order to examine accuracy, make adjustments and improve our methodology. Over the past four calendar years, we have backtested our methodology and found that our 10-year projected returns were quite accurate. Exhibit 3 is a comparison of our published 2011 capital market assumptions and actual returns over the past 10 years. The white lines represent our expected returns from 10 years ago, with the top and bottom of the bars representing plus and minus two standard deviations from the expected return. Actual returns over the past 10 years are represented by the circles. As the chart demonstrates, actual returns for each asset class and a hypothetical balanced portfolio easily fell within the two standard deviation range. Actual returns for U.S. equity were generally higher than expected, and the opposite held true for international equity. Expected returns for fixed income were extremely close to actual returns. Hedge funds slightly underperformed expectations. The analysis also demonstrates the value of diversification. A balanced portfolio of 55% equity, 30% fixed income, and 15% alternatives had an expected return of 6.7%, close to the actual return of 7.7%. Though certain asset classes - especially those with high volatility - can be challenging to predict individually, 25.0 a well-diversified portfolio can be predictable over the long term. 20.0 Exhibit 3: 2011 Capital Market Assumptions vs. Actual 10-Year Returns Ending 11/30/2020 15.0 +2 Standard Deviations 10.0 25.0 2011 Expected Return Actual 10-Year Return 5.0 20.0 -2 Standard Deviations 0.0 14.3 15.0 12.7 11.1 -5.0 9.8 9.5 Annualized Annualized Return (%) 10.0 8.4 8.4 7.7 7.5 9.0 9.4 9.0 5.5 6.8 5.0 6.2 3.6 3.7 6.7 Annualized Return (%) U.S. REIT 4.1 3.0 Hedge Funds U.S. High Yield 0.0 Emerging Equity Balanced Portfolio* U.S. Mid Cap Equity U.S. Small Cap Equity U.S. Large Cap Equity -5.0 International Dev. Equity U.S. Aggregate Fixed Income U.S. REIT U.S. Hedge Funds Hedge U.S. High Yield Emergi ng Equi ty BalancedPortfoli o* U.S. Mid Cap Equity Cap Mid U.S. U.S. Small Cap Equity Cap Small U.S. U.S. Large Cap Equi ty International Dev. Equity Dev. International U.S. Aggregate Fixed Income Fixed Aggregate U.S. *Assumes a hypothetical balanced portfolio with weights of 20% U.S. large cap equity, 7% U.S. mid cap equity, 4% U.S. small cap equity, 16% international developed equity, 6% emerging equity, 2% U.S. REIT, 25% U.S. Aggregate fixed income, 5% U.S. high yield, and 15% hedge funds. Source: BNY Mellon Investor Solutions, Bloomberg. 5 10-Year Capital Market Assumptions Macroeconomic Backdrop When building capital market assumptions, we start with projections of inflation, real GDP growth, short-term interest rates and currency rates. Inflation and real GDP growth are key drivers of our expected earnings growth for equity. Projections of inflation and real cash rates are extremely influential in projecting fixed income yields and returns. The economic projections underpinning our asset class return assumptions are based on four economic scenarios outlined in BNY Mellon Investment Management’s 2021 Q1 Vantage Point. These scenarios are summarized in Exhibit 4. We develop return expectations under each of these scenarios, then probability weight the returns to determine our overall “expected” return. This approach allows us to not only analyze portfolios based on the expected case, but also to shock the portfolio under the various scenarios. We encourage you to read the latest Vantage Point to learn more about our economic projections. Exhibit 4: Summary of Macroeconomic Scenarios 50% 20% 15% 15% Probability Probability Probability Probability Good Inflation Bad Permanent Recovery Surprise Recovery Damage • Successful global rollout • The recovery is stronger • Vaccines turn out to be • Long-lasting economic of the various vaccines than expected with GDP less effective and more damage through • Economic activity picks quickly returning to pre- difficult to roll out fundamental forces and up very strongly in Q2 crisis levels.

Load more