Tag Archives: etfs

The ‘Relatively’ Easy Way To Forecast Long-Term Returns

By Andrew Perrins Long-term returns are relatively easy to forecast. Short-term returns are dominated by randomness, but long-term forecasts for most asset classes can, in part, be derived mathematically (give or take some arguing about the assumptions). But why bother with long-term return expectations – for example, 10-year forecasts? For most multi-asset managers or tactical asset allocators, 10 years is an eternity. Investment managers are judged on much shorter time frames. For asset owners or asset managers compiling a strategic asset allocation, however, long-term forecasts are relevant and necessary. When combined with estimates for risk and correlation, these forecasts allow investors to fine-tune their long-term benchmarks and consider trade-offs between asset classes to enhance the implied risk and return profile of the fund. In the following table, I have aggregated the results from three major asset managers – JP Morgan , Northern Trust , and BNY Mellon – that publish their long-term return forecasts for major asset classes. Here are the average expected returns: Average Long-Term Return Forecasts Asset Class Average Forecast (per annum) US inflation 2%-2.5% US cash 2%-2.5% US 10-year bonds 2%-2.5% Commodities 2%-3% Hedge funds 4%-5% US equities 6%-7% Global equities 6%-8% Private equity 8%-9% Let’s think about how these estimates are derived and whether they are realistic. Fixed-income securities are the obvious starting point. If we buy a 10-year Treasury today with a redemption yield of 2.5% and hold it to redemption, we know that the return will be 2.5% per annum (assuming that the US government doesn’t default). The Return from US Equities Now, let’s consider US equities. The simplest expression of the truly long-term return from US equities follows a classical formula, as described by Richard Grinold and Kenneth Krone r: Long-term return from equities = Dividend yield + Inflation + Real earnings growth Long-term return from equities = 2.0% + 2.25% + 2.25% = 6.5% So, at first glance, if you believe the assumptions – that inflation will be around 2.25% and that dividends will grow pretty much in line with long-run GDP expectations – then the forecast above is reasonable. What’s not to like? Let’s unwrap this in more detail. First, should we adjust for buybacks? In reality, the payback to long-term (buy and hold) investors will be both in dividends and in capital return from share buybacks. It’s reasonable to assume that substituting buybacks for dividends makes no substantive difference to total long-term returns, although some of the publications linked in this post explore the building blocks behind this in impressive detail. Second, is it reasonable to assume that dividend growth (or earnings growth) will keep pace with the real economy? Can the profit share of GDP hold at its current level? A recent report from McKinsey & Company is forecasting that more competitive world markets will trigger a 20% fall in global profit share by 2025. Also, even if profit share holds near to recent highs, can the companies that currently make up the index maintain their own profit share as new players and technologies emerge? My personal expectation is that earnings growth will not match real GDP growth in the long run. You may have your own view. Third is the question of equity market valuation. If we are considering a finite time horizon (let’s say 10 years), then our formula above only holds if the dividend yield remains constant. If it is likely to change, we need to make a valuation adjustment. It is for this reason that the estimate of long-term US equity returns from from our fourth research publication is starkly different from those above. Rob Arnott’s team at Research Affiliates forecasts that, over the next 10 years, the valuation of the US equity market (as measured by the Shiller CAPE ratio) will revert halfway back to its long-term average. This implies a valuation adjustment of 2.4% per annum. When added to a dividend yield of 2% and their estimate of dividend growth of 1.4% per annum, this gives a prospective 10-year total return from US equities of just 1.0% per annum. Whom do you believe? Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

4 Takeaways On Alternative Opportunities Today

By Marc Gamsin, Greg Outcalt Dispersion among asset classes and individual stocks and bonds will likely increase, and that’s only one trend reshaping the landscape and redefining alternative investing opportunities. Here are four things investors should consider. 1) Higher dispersion is creating fertile ground for long/short strategies. The environment, particularly in the US, is favorable for long/short strategies. To start with, corporate and economic fundamentals are strong. We’re also seeing more volatility and dispersion – bigger distinctions between security valuations mean more active-management potential. And even though the US equity market seems fully-valued overall, we still think there are misvaluations that make long/short approaches attractive. We particularly favor strategies that can leverage increased dispersion if there’s an uptick in volatility. These strategies should use bottom-up, fundamental analysis to exploit long/short idiosyncratic – or security-specific – opportunities. We also think strategies that can take advantage of the impact of divergence in central bank policies could benefit. Interest rates are low, markets for equity and credit financing are open, and there’s been a multiyear bull market. This combination has enabled low-quality companies to survive and go public, engage in financial engineering including undesirable buybacks, and increase their debt loads. These activities are increasing the available opportunities to take short positions. 2) The environment is strong for corporate deal making. Macroeconomic fundamentals, including low oil prices, low funding costs and strong corporate balance sheets, are fueling strong deal activity. This is creating an attractive environment for event-driven investing. Corporate activity is near record highs in a number of areas, including new IPOs, spinoffs and mergers. Many of these activities result in changes to corporate structure, balance sheet composition, incentives and management quality. These events, in turn, create potential both on the long and short sides. And because organic revenue growth is otherwise challenged in the low-growth economic environment, corporate deals continue to offer solutions that could be compelling for companies. We think the ability to invest across equity and credit markets is a key to capitalizing. 3) Relative value approaches face headwinds. The environment remains challenging for relative-value credit strategies, and volatility could be high. In terms of fundamentals, debt levels at US high-yield firms are at record highs, and the ratio of downgrades to upgrades is at a post-crisis high – both are concerns. These and other factors have limited the potential upside, particularly relative to the potential downside in price. What about liquidity and market structure? Liquidity in many areas is low, even as money flowed into credit-focused investments. We think this backdrop sets up the possibility of investors being forced to sell into a less liquid market if an unexpected event occurs. Offsetting some of this risk is what seems to be a sizable amount of cash on the sidelines, ready to prop up higher-quality issues if there’s a broad-based dislocation. Of course, the environment can change quickly if an economic downturn or market decline expands distressed credit opportunities. This would be especially true after a long bull market, in which weaker firms have been able to easily raise new debt and extend debt maturities. Strategies nimble enough to move into these areas of opportunity as they emerge could find a very rich opportunity set. 4) Some promise in emerging macro trends…with a caveat. Macro-level trends are becoming more prominent, creating more appealing opportunities than in recent years. There are mounting geopolitical risks, including tensions in Ukraine and Russia, the threat of ISIS and economic question marks in the euro area. Heavy government debt is combining with slower global growth, market volatility is rising, and central bank policies are diverging. In emerging markets, lower commodity prices are causing dislocations. And when the US Federal Reserve raises interest rates, it should boost the dollar and put downward pressure on longer-term bonds. This environment could provide the foundation for several long-term trends, creating potential for macro strategies. However, the long-term potential for strategies that haven’t yet experienced a low-but-rising interest-rate environment remains unknown. And the concentrated bets and high levels of leverage that these strategies often use continue to give us pause. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Marc H. Gamsin, Head and Co-Chief Investment Officer – Alternative Investment Management Greg Outcalt, Co-Chief Investment Officer – Alternative Investment Management

3 Best-Ranked Small-Cap Value Funds For Higher Return

Small-cap value mutual funds provide excellent choices for investors who are looking for bargain, i.e., stocks at a discount, with an impressive growth potential. Value mutual funds are those that invest in stocks trading at discounts to book value, have a low price-to-earnings ratio and high dividend yields. Value investing has always been popular, and for a good reason. After all, who doesn’t want to find stocks that have low PEs, solid outlooks and decent dividends? Meanwhile, a small-cap fund is a good choice for investors with a high risk appetite as companies with small market capitalization are expected to have higher growth potential than large- and mid-cap companies. Small-cap funds generally invest in companies having market cap lower than $2 billion. Also, small-cap funds are expected to provide diversification across sectors and companies. Below, we share with you three top-rated, small-cap value mutual funds. Each has earned a Zacks Mutual Fund Rank #1 (Strong Buy) and we expect the funds to outperform its peers in the future. CRM Small Cap Value Investor (MUTF: CRMSX ) seeks capital growth over the long run. CRMSX invests a large chunk of its assets in equity securities of small-cap companies that are believed to be undervalued. CRMSX invests in securities of companies having market capitalization similar to those listed in the Russell 2000 Value Index. CRMSX invests in companies throughout the globe but traded in the US. The CRM Small Cap Value Investor fund has a three-year annualized return of 13.2%. CRMSX has an expense ratio of 1.09% as compared to the category average of 1.23%. Nuveen NWQ Small/Mid-Cap Value A (MUTF: NSMAX ) invests the lion’s share of its assets in companies with market capitalization within range of the Russell 2500 Value Index. Though NSMAX invests in both small- and mid-cap companies, currently, it has major parts of its assets invested in small-cap stocks. NSMAX invests a maximum of 35% of its assets in foreign companies with not more than 10% of its assets allocated in companies from emerging economies. The Nuveen NWQ Small/Mid-Cap Value A fund has a three-year annualized return of 9.5%. Phyllis G. Thomas is the fund manager of NSMAX since 2010. JPMorgan Small Cap Value A (MUTF: PSOAX ) seeks long-term capital appreciation. PSOAX uses the value-based strategy to invest in equity securities of small-cap firms having market capitalization similar to those included in the Russell 2000 Value Index. PSOAX primarily invests in common stocks and REITs. The JPMorgan Small Cap Value A fund has a three-year annualized return of 11.8%. As of August 2015, PSOAX held 391 issues with 1.16% of its assets invested in Cooper Tire & Rubber Co (NYSE: CTB ). Original Post