Capital Market Assumptions: A Building Block Methodology
The Invesco Global Solutions Development and Implementation team (Invesco Global Solutions) is dedicated to designing outcome-oriented, multi-asset portfolios that meet the specific goals of investors. Capital market assumptions (CMAs) are key to this effort. CMAs provide the necessary foundation for creating long-term forecasts for the behavior of different asset classes. Specifically, for each of the asset classes in which we invest, we develop assumptions with regard to expected return, standard deviation of return (volatility) and correlation with other asset classes. We evaluate current and historical market data, in the context of a 10-year investment horizon, in order to develop guidelines for our long-term, strategic asset allocation decisions.
This document details our long-term asset class forecasts and the supporting methodology. Invesco Global Solutions’ CMAs encompass a broad array of asset classes across equity, fixed income and commodity markets globally.
Expected returns: A ‘building block’ approach to forecasting returns
We employ a fundamentally based "building block" approach to forecasting asset class returns. Building blocks represent a “bottom-up” approach where the underlying drivers of asset class returns are used to form estimates.
- First, these sources of return are identified by deconstructing returns into income and capital gain components.
- Next, estimates for each driver are formed using fundamental data such as yield, earnings growth and valuation, and combined to establish expected return forecasts.
By incorporating fundamental data, our approach allows for the relative attractiveness of asset classes to vary over time. Other approaches based on historical relative returns can provide relatively static estimates through time where certain asset classes contain constant return advantages. The following section will detail and present the estimates across various equity, fixed income and commodity asset classes.
The building block methodology reflects a total return approach to equities — accounting for both income and capital appreciation (i.e., the change in price over time). The building blocks of our forecast therefore consist of estimates for yield (as a driver of income) and earnings growth and valuation change (as drivers of capital appreciation). We begin the forecast by looking at large-cap US equities.
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