FEBRUARY 2019 Capital Market Assumptions Call

Transcription

1 FEBRUARY 2019 Capital Market Assumptions Call

2 Call instructions Expand Collapse VERUSINVESTMENTS.COM SEATTLE LOS ANGELES SAN FRANCISCO Full Screen Use the orange arrow to expand or collapse the control panel Thank you for joining us for our quarterly Investment Landscape Call. Stay tuned, the call will begin shortly. Ask questions here Questions Verus Quarterly Investment Landscape 2

3 conference call IMPORTANT INFORMATION Dial in: 1 (877) U.S. & Canada VERUSINVESTMENTS.COM SEATTLE LOS ANGELES SAN FRANCISCO Access code: Audio options: You may choose to listen through the webcast on your computer or dial in. Presented by: Ian Toner, CFA Chief Investment Officer Thomas Garrett, CFA, CAIA Sr. Associate Director Strategic Research Andrew Akers, CFA Sr. Strategic Research Analyst Consulting Outsourced CIO (OCIO) Risk Advisory Private Markets 3

4 Key takeaways Lower equity valuations, higher credit spreads, and higher interest rates indicate a moderate improvement in 10-year capital market return forecasts However, an environment of continued low inflation and low interest rates would suggest more muted asset class performance relative to the historical average It is important to note the different nature of shorter and longer-term expectations 2019 CMA Call 4

5 Verus Capital Market Assumptions High-Level Methodology How does Verus forecast asset class and portfolio behavior? 2019 Capital Market Assumptions What do our forecasts look like for the next 10 years? How do these forecasts compare to last year? How do they compare to history? Investor Takeaways What do capital market assumptions mean for building portfolios? 2019 CMA Call 5

6 Building block methodology Output: the sum of the building blocks equals expected return + + Income Inflation Real Growth EXPECTED RETURN BUILDING BLOCKS For illustrative purposes only 2019 CMA Call 6

7 Build-up/spread Output: the sum of the building blocks equals expected return Income Inflation Real Growth + Premium EXPECTED RETURN BUILDING INPUTS For illustrative purposes only 2019 CMA Call 7

8 Expected return methodology BUILDING BLOCK METHODOLOGY Cash Bonds Credit International Credit Equity Commodities Core Real Estate Infrastructure Real yield estimate + inflation forecast Nominal bonds: current yield; Real bonds: real yield + inflation forecast Current option-adjusted spread + U.S. 10-year Treasury effective default rate Current option-adjusted spread + foreign 10-year Treasury effective default rate Current yield + real earnings growth (historical average) + inflation on earnings (inflation forecast) + expected P/E change Collateral return (cash) + spot return (inflation forecast) + roll return (assumed to be zero) Cap rate + real income growth capex + inflation forecast Current yield + real income growth + inflation on earnings (inflation forecast) BUILD-UP/SPREAD METHODOLOGY Private Equity Private Credit U.S. large cap domestic equity forecast * 1.85 beta adjustment Bank loan forecast % private credit premium 2019 CMA Call 8

9 Expected return methodology 7% 6% 5.8% 6.1% 5% 4% 4.1% 3% 2.7% 2% 1% -1% U.S. Treasury U.S. Investment Grade Credit U.S. Large Cap Equity Core Real Estate Income Inflation Real Growth Default Valuation Change Expected Return Source: Verus 2019 CMA Call 9

10 U.S. equity historical return building blocks Jan-36 Jan-56 Jan-76 Jan-96 Jan-16 Jan-36 Jan-56 Jan-76 Jan-96 Jan-16 Dividend Yield Inflation Growth Real Earnings Growth Repricing Return 10 Yr. Rolling Return Source: S&P, Shiller, as of 9/30/ CMA Call 10

11 10-year expected returns 1 9% 8.8% 8.6% 8% 7% 7.8% 7.7% 6.9% 6.7% 6.5% 6.1% 6% 5.9% 5.8% 5.7% 5.4% 5% 4% 4.4% 4.3% 4.2% 4.1% 3% 2% 1% 3.3% % 2.7% 2.1% 0.8% Source: Verus Equity Real assets/alts Fixed income 2019 CMA Call 11

12 2019 vs return forecast % 2.5% % 1.5% % % 0.7% 1.3% 0.8% 0.8% % 0.7% 0.5% 0.4% 0.3% 0.4% 0.3% 0.4% 0.4% 0.2% % % Note: the year-over-year change is based on the 2019 methodology 2019 CMA Call 12

13 Required forecasting inputs Output: Expected future behavior of asset classes and portfolios Expected return Expected volatility Correlation matrix Return distribution assumption CAPITAL MARKET ASSUMPTION INPUTS 2019 CMA Call 13

14 What is in a forecast? Expected return: 5.8%, standard deviation: 15.6% Tail characteristics (How often do extreme events occur?) Median (expected average outcome) A return forecast is simply the average expected return A volatility forecast tells us how different the return might actually be -15% -1-5% 5% 1 15% 2 25% Volatility (how variable is the expected outcome?) 2019 CMA Call 14

15 Returns are not normally distributed Empirical analysis: U.S. equity monthly returns since 1950 FULL DISTRIBUTION OF RETURNS VS. NORMAL 14% LEFT-TAIL RETURNS VS. NORMAL 0.8% 12% 1 8% 6% 4% 2% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% -25% -2-15% -1-5% 5% 1 15% 2 25% % -23% -21% -19% -17% -15% -13% -11% -9% Source: Verus, Standard & Poor s 2019 CMA Call 15

16 Range of likely 10 year outcomes U.S. LARGE CAP EQUITY Return % 1 15% 2 25% Path Risk 2019 CMA Call 16

17 Range of likely 10 year outcomes 10-YEAR RETURN 9 CONFIDENCE INTERVAL 25% 2 15% 1 5% -5% -1 High Volatility 5th to 25th 25th to 50th 50th to 75th 75th to 95th Expected Return Low Volatility 2019 CMA Call 17

18 Equity 2019 CMA Call 18

19 Equity return forecasts 1 8.6% 8% 7.7% 6% 5.8% 5.4% 6.5% 4% 2% -2% U.S. Large U.S. Small Intl Developed Large Intl Developed Small Emerging Markets Dividend Yield Inflation Real Earnings Growth Valuation Change Expected Return Source: Verus 2019 CMA Call 19

20 U.S. equity expected vs. history 14% 12% % 10.6% 8% 6% 5.8% 5.7% 4% 2% -2% -4% 10-Year Expected 30-Year Expected 10-Year Historical 30-Year Historical Income Inflation Real Earnings Growth Valuation Change Total Return 2019 CMA Call 20

21 U.S. equity return building blocks 10-YEAR ROLLING INCOME RETURN 6% 5% 4% 3% 2% 1% Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10 Dec YEAR ROLLING INFLATION (CPI) 1 9% 8% 7% 6% 5% 4% 3% 2% 1% Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10 Dec YEAR ROLLING REAL EARNINGS GROWTH 15% 1 5% -5% -1-15% -2-25% Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10 Dec-15 TRAILING 12-MONTH P/E RATIO 35 Average Dec-80 Dec-85 Dec-90 Dec-95 Dec-00 Dec-05 Dec-10 Dec CMA Call 21

22 U.S. equity 10-year rolling returns 25% 2 Average of 10-year rolling periods 15% 1 5% -5% -1-15% Dec-37 Dec-42 Dec-47 Dec-52 Dec-57 Dec-62 Dec-67 Dec-72 Dec-77 Dec-82 Dec-87 Dec-92 Dec-97 Dec-02 Dec-07 Dec-12 Dec-17 Source: Bloomberg, S&P 500 Index, as of 12/31/ CMA Call 22

23 Fixed income 2019 CMA Call 23

24 Fixed income return forecasts 1 8% 6% 4% 2% 2.1% 2.7% 3.3% 4.1% 5.7% 5.9% 2.1% 6.7% -2% -4% Cash U.S. Treasury U.S. Core U.S. Core Plus U.S. High Yield Bank Loans Global Credit EMD Hard Inflation Treasury Yield* Credit Spread Effective Default Expected Return Source: Verus *Bank loans uses 3-month USD Libor instead of the Treasury yield 2019 CMA Call 24

25 Portfolio expectations 2019 CMA Call 25

26 Portfolio expected returns 8% 7.3% 7% 6.7% 6% 5.8% 5% 5.1% 4% 3% 2% 1% Domestic 60/40 Global 60/Domestic 40 Expected Return Average of Rolling 10-Year Periods since 1990 Source: Verus, Morningstar, as of 12/31/18, indices used include the S&P 500 Index, MSCI ACWI Index, and BBgBarc U.S. Aggregate Index 2019 CMA Call 26

27 10-year rolling returns 18% 16% 14% 12% Average of 10-year rolling periods 1 8% 6% 4% 2% -2% -4% Dec-37 Dec-42 Dec-47 Dec-52 Dec-57 Dec-62 Dec-67 Dec-72 Dec-77 Dec-82 Dec-87 Dec-92 Dec-97 Dec-02 Dec-07 Dec-12 Dec-17 Domestic 60/40 Real Returns Domestic 60/40 Nominal Returns Average Real Average Nominal Source: IA SBBI, as of 12/31/ CMA Call 27

28 Longer vs. shorter-term expectations 10-year forecasts should typically not be used for shorter-term positioning Longer-term return drivers Level of inflation Level of interest rates Level of growth Level of asset prices Shorter-term return drivers Changes in inflation level & expectations Changes in interest rate level & expectations Changes in growth level & expectations Changes in asset prices Shorter-term investment strategy should be focused on identifying changes in the environment An investor s longer-term & shorter-term expectations will often be different 2019 CMA Call 28

29 Q&A Expand VERUSINVESTMENTS.COM SEATTLE LOS ANGELES SAN FRANCISCO Use the orange arrow to expand the control panel Thank you for joining us for our quarterly Investment Landscape Call. Stay tuned, the call will begin shortly. Ask questions here Questions Verus Quarterly Investment Landscape 29

30 Thank you 2019 CMA Call 30