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If the smart-beta folks at Research Affiliates are your idea of wise asset allocation, then you can get a thoroughgoing idea what the Newport Beach, California-based fundamental indexers think of expected returns over the next 10 years in everything from equities, bonds, currencies, commodities and more.
The value-oriented investment strategists known for indexes that weight according to fundamental criteria such as price to book rather the capitalization weight of stocks have unveiled a new “Expected Returns” website this month, laying bare their precise market estimates.
For example, the firm’s Q3 10-year forecast for equities is 2.7% average annual return, volatility of 17% and a yield of 2.2%.
Discouraged by that relatively high-risk, low-return investment?
Then simply cast your eyes upward to the higher end of the real expected returns axis, and see that Research Affiliates expects a 6.3% real average annual return for MSCI’s emerging markets equity index, albeit at the cost of much higher volatility of 23.9%.
Are broad equity indexes not your speed? Like the thrills of the country index investing? The Expected Returns site allows you to drill down and see, for example, that U.S. large equities are forecast to deliver a pathetic 1% over the next decades.
While that beats the negative half-percent average return of cash, the large-cap stocks comes with the wild ride of 17% volatility compared to zero volatility for cash. Far less attractive than large stocks, according to Research Affiilates’ model, are small stocks, set to return 0% over 10 years, but with a roller-coaster ride of nearly 20% volatility.
Russia, in contrast, is forecast to provide annual returns of 13.8%, albeit with white-knuckle volatility of 36.1%. The MSCI UK stock index might be something closer to a sweet spot for more risk-averse investors, with 5.2% expected returns and 18.1% volatility.
But the foregoing represents journalistic fun rolling over website bells and whistles. The serious folks at Research Affiliates introduced their public launch of their asset allocation ideas with a statement of their investment beliefs — perhaps a reminder of why some investors might prefer to pay them to manage their money.
Their core belief is that long-term reversion to the mean is the key driver of investment return — for those willing to bear the emotional costs of owning the sort of value stocks that are typically unloved by most investors.
Indeed, the authors of this statement of beliefs — Chris Brightman, James Masturzo and Jonathan Treussard — make clear that, contrary to what many would assume, investing is not a simple risk-return calculation. If it were, investors would be chasing the same investments that Research Affiliates is seeking.
Rather, deep-seated behavioral calculations drive investors to follow the herd or to not be seen as an outsider. Pride and a quest for status via association with prestigious companies or avoidance of unpopular ones is another source of investor behavior, as are gambling and its opposite, loss aversion.
Research Affiliates regards these behaviors as alternative, rather than irrational, investor preferences.
Another key investment belief is that security prices vary, often over extended periods, and they convey more than current offers. Investors can know the path they’ve taken to get to their current level, which aids in gauging which assets are overpriced and which underpriced.
The authors cite a classic study by Werner DeBondt and Richard Thaler comparing a portfolio of “winning” stocks (that had performed well over the past three years) and “losing” stocks. The latter category outperformed the “winners” by nearly 25% over the subsequent three years (based on an average of 16 three-year test periods).
Though this research has been widely publicized, the Research Affiliates team has no fear that its competitors will rush into to buy the same “loser” stocks they want because of their belief in their rivals’ lack of conviction (or internal governance constraints).
The inability of professional investors to exploit these mispricings was brought home to one of the authors who attended a meeting of university endowment managers in the aftermath of the 2008 market meltdown.
There he observed “the near universal desire … to shed more of their exposures to depressed assets … at the exact time that a once-in-a-generation buying opportunity presented itself.”
Implementing these core principles, which in essence entail the courage to buy low, stay the course and then sell high, require analytic tools for operational, daily investing —“a roadmap anchoring our view of what the future holds.”
And that is the research-driven firm’s long-term capital market forecasts, which they are now sharing with the public. Interested investors can even submit their email address to receive instant notification of the firm’s forecasts, which they update quarterly.
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