Feb 25, 2021 Multi Asset

DWS Long View - The green decade

Francesco Curto

Francesco Curto

Global Head of Research, DWS
Jason Chen

Jason Chen

Senior Portfolio Strategist
Dirk Schlüter

Dirk Schlüter

Co-Head, DWS House of Data
  • Return forecasts in most asset classes are well below the returns achieved over the past decade, illustrating ongoing challenges for long-term investors.
  • ESG equity forecasts are modestly higher than market-cap-weighted indices across regions
  • Relative to traditional assets, we forecast higher returns across a number of key alternative asset classes
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This publication details the long-term capital market views that underpin the strategic allocations for DWS’s multi-asset portfolios. These estimates are based on 10-year models and should not be compared with the 12-month forecasts published in the DWS CIO View.

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Executive summary

There is no shortage of challenges as we officially enter a new decade. While economic growth is likely to gradually normalize over the next few years, the potential for longer lasting COVID-19 impact remains. Many restrictions on goods production may remain, with production diversified to more locations at the cost of some economies of scale. Similarly, more inventory requirements are likely to be required. The prioritization of addressing climate change will likely shift the composition of the global economy toward one more focused on long-term environmental sustainability.

At the outset of the year, asset prices remained elevated, carrying momentum from the continued sanguine economic growth and a decade of supportive monetary policy. Growth prospects remain challenged, particularly across developed economies, due to intensifying demographic shifts as baby boomers continue to retire and working-age populations continue to shrink. To close out the year, valuations across assets—elevated equity multiples, compressed credit spreads, and historically low treasury yields—reflected little anticipated change in economic or market conditions. These elevated valuations reflect the magnified support for financial markets provided by global central banks over the course of this year. Taking these factors into consideration, we present our long-term ten-year return forecasts across asset classes which we refer to as our “Long View”.

In our Long View, we show our forecasted returns across asset classes and regions on the efficient frontier, which represents the trade-off investors have to make between risk and returns. The chart below depicts the efficient frontier over the last ten years since the credit crisis and compares it to the efficient frontier over the past two decades. As seen, the post-financial crisis efficient frontier is steeper. What this suggests is on a relative basis, investors received greater compensation for commensurate levels of risk in the decade following the financial crisis.

In an environment of more conservative asset-class return expectations, strategic asset allocation becomes increasingly important, utilizing a rigorous and disciplined approach to portfolio construction. The prevalence of ESG investing over the past year alone has been quite dramatic across almost all segments of asset markets and will continue to be a building block for investor portfolios. Thus, for the first time, we incorporate a number of important regional ESG indices into our return forecasts.

This publication details the long-term capital market views that underpin the strategic allocations for DWS’s multi-asset portfolios. These estimates are based on 10-year models and should not be compared with the 12-month forecasts published in the DWS CIO View.

Efficient frontiers: Forecasted and historical returns and volatilities, annualised

Fig 6_CHART_72DPI.png

Historical Efficient Frontiers are noted above as “Efficient Frontier” and are calculated using historical returns and volatilities over the time frame noted through 12/31/20. Each historical efficient frontier represents the risk-return profile of a portfolio which consisted of two asset classes; World Equities (in euro, unhedged) and Global Aggregate Fixed Income (euro-hedged). The Long View Efficient Frontier represents a forecasted optimal portfolio (EUR) using the various asset classes represented in the figure, subject to certain weighting/concentration constraints that result in component asset classes being able to trade above the line in this instance (please see page 25 for more details on these optimisation techniques). Source: DWS Investments UK Limited. Data as of 12/31/20. See appendix for the representative index corresponding to each asset class

Central to this document is our belief that clients should consider a long term perspective beyond 1–5 years when it comes to constructing investment portfolios. Perhaps, counterintuitively, extending the investment horizon has, in the past, produced less volatile, more precise forecasts, as shown in below: while risk still matters and there is still a distribution of investment outcomes around any central forecast, this distribution has tended to become narrower when investing for longer investment horizons. One consequence of this is that entry points become less relevant (even though of course by no means irrelevant) for longer investment horizons (because cyclical and tactical drivers are overtaken by fundamental, structural drivers of asset class returns).

For example, we believe that many asset-class valuations are high today relative to history. But taking one of the biggest previous bubbles (the dot.com boom) as an example, the difference between buying exactly at the peak of the dot.com boom in April 2000 vs. a year later only amounts to one percent compounded annually when
investing with a 15-year time horizon (as we show on page 17 in the PDF). However, if an investor had had a shorter horizon of five years, the difference in returns generated from buying at the peak versus one year later was greater, amounting to roughly six percent per annum. Thus, while asset prices may be high today relative to history, over long-run periods (15 years in this example), returns seem to be driven by their underlying fundamental building blocks.

When looking at rolling one-year price returns of the S&P 500 from 1871 to 2019, a negative two-standard-deviation move equated to a 27 percent decline in prices. When calculating a negative two-standard-deviation move using rolling 10-year returns over this same time frame, the decline in prices is less than 1 percent per annum. More stable long-run returns can be helpful in establishing more stable strategic-asset-allocation targets.

Hence, sceptics may be surprised to learn that the volatility of returns historically has been lower when using long-term horizons, although past performance may not be indicative of future results.

Asset allocation and risk allocation by target volatility

Fig 7_A_CHART_72DPI.png

Source: DWS Investments UK Limited. Data as of 12/31/20. For illustrative purposes only. See page 25 for details. See appendix for the representative index corresponding to each asset class.

Fig 7_B_CHART_72DPI.png

Distribution of U.S. equities: Historical returns over different time periods, annualised

Fig 8_CHART_72DPI.png

Past performance may not be indicative of future returns.
Source: Robert J. Shiller, DWS Investments UK Limited. Data from 1871 to 2020.

Framework

We use the same building-block approach to forecasting returns irrespective of asset class. We believe this brings consistency and transparency to our analysis and also may help clients better understand the constituent sources of returns.

The Long View framework breaks down returns into three main pillars: income + growth + valuation, each with their own sub-components.

The pillars and components for the traditional asset classes under our coverage (equities, fixed income and commodities) are shown below.

Meanwhile, alternative asset classes under our coverage (listed real estate, private real estate, real estate debt, listed infrastructure equity and private infrastructure debt) are forecasted using exactly the same approach, sometimes with an added premium to account for specific features, such as liquidity.

The Long View framework breaks down returns into three main pillars: income + growth + valuation, each with their own sub-components.

Long View for traditional asset classes: Pillar decomposition

Fig 9_CHART_72DPI.png

Forecasts are based on assumptions, estimates, views and or analyses, which might prove inaccurate or incorrect.
Source: DWS Investments UK Limited. As of 12/31/20.

Long View for alternative asset classes: Pillar decomposition

Fig 10_CHART_EN_72DPI.png


Source: DWS Investments UK Limited. As of 12/31/20.

Return forecasts

Our Long View forecasts for all asset classes can be seen below. The bars are ranked by ascending forecasted return within each asset class.

In summary, we make the following key observations from the results:

  • Return forecasts in almost all asset classes are well below the returns achieved over the past decade, illustrating ongoing challenges for long-term investors.
  • Across regional equity markets, the US and emerging markets are expected to offer the highest forecasted returns.
  • ESG equity forecasts are modestly higher than are market cap-weighted indices across regions (see Table 2 in the PDF).
  • Fixed income returns may be challenging, with emerging-market U.S. dollar (USD) sovereign and corporate bonds appearing to offer the highest forecasted returns.
  • Relative to history, the return forecasts for credit (across IG and HY corporates as well as sovereign and corporate EMD) are near or below the lowest 10-year returns realized by these asset classes over the past several decades, including the financial crisis.
  • Relative to many other asset classes, we forecast higher returns in many of the alternative asset classes covered (even though this premium has shrunk somewhat versus traditional risky asset classes); the highest return forecast in the major asset classes is currently found in private real estate.
  • Return forecasts from commodities are low (especially in real terms) but they could provide useful diversification benefits.
  • Investors should be conscious of the impact of foreign-exchange (forex) risk on base-currency returns and volatilities. Depending on risk appetite and return objectives, investors may want to consider hedging currency risk (see page 31 in the PDF).

Forecast and realised returns for 10 years, annualised (local currency)

Fig 11_CHART_72DPI.png

Past performance may not be indicative of future returns. Forecasts are based on assumptions, estimates, views and hypothetical models or analyses, which might prove inaccurate or incorrect. Any hypothetical results may have inherent limitations. Among them are the sharp differences which may exist between hypothetical and actual results which may be achieved through investment in a particular product or strategy. Hypothetical results are generally prepared with the benefit of hindsight and typically do not account for financial risk and other factors which may adversely affect actual results.
Source: DWS Investments UK Limited. As of 12/31/20. See appendix for the representative index corresponding to each asset class.

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