Invesco Canada blog

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Duy Nguyen and Jacob Borbidge | October 8, 2018

Capital market assumptions: How we estimate asset-class returns

Our views of equities, fixed income and alternatives shape our multi-asset portfolios and inform our clients

Capital market assumptions (CMAs) are fundamental to the Invesco Global Solutions team and our work as multi-asset investors. These are our long-term estimates for the behaviour of different asset classes, and they serve as the foundation for allocations across equities, fixed income, commodities and alternatives in our portfolios.

Estimates for these asset classes are mostly based on a “building-block methodology” that examines the underlying drivers of asset-class returns. Let’s take a closer look at the building blocks for equities, fixed income and commodities, and at our outlook for these asset classes over the long term.


The building blocks for our view of equities reflect a total-return approach – accounting for both income and capital appreciation. Our estimates for the building blocks therefore include yield, as a potential driver of income, as well as earnings growth and valuation change, as potential drivers of capital appreciation:

For each of these, we determine what we believe is the most appropriate approach for defining and estimating the building block. For example, we use real gross domestic product per capita to estimate earnings growth. In addition, this methodology allows us to extend our estimates to cover all segments of the equity markets in terms of size, investment style and geography.

As of the beginning of the third quarter of 2018, our quarter-over-quarter 10-year return estimates for equities globally moved broadly higher, driven primarily by higher yields and cheaper valuations. A slight uptick in global inflation is also pushing nominal earnings-growth expectations slightly higher. Exceptions to this include equity markets in Australia and Canada, where yields have decreased, and valuations are closer to fair value or slightly above the median.

Fixed income

The building blocks for fixed-income return include yield as a potential driver of income and roll return, valuation change and credit loss as potential drivers of capital appreciation:

With regard to fixed income this quarter, 10-year return estimates range from broadly unchanged to slightly higher, relative to last quarter. If we take a closer look at the impact of individual drivers, we see the following:

• Overall yields are higher

• The U.S. Treasuries yield curve is generally flatter, with the short-term yields slightly higher and the long end roughly unchanged

• Credit spreads have widened, generating a tailwind for credit-sensitive bonds

However, return estimates have decreased for

• U.S. bank loans, due to slightly lower yields;

• high-yield municipal bonds, due to declining spreads; and

• long-duration bonds, due to a flatter term structure.


To estimate commodities returns, we analyze the futures curve, which is a graphical representation of commodity contracts that expire at different maturities. As with other asset classes, we apply the building-block approach to the futures curve to identify the main constituents of total return – collateral return as a potential driver of income and roll and spot returns as potential drivers of appreciation:

Overall, our estimates for commodities-return expectations continue to increase this quarter, driven by higher future expected spot prices and higher returns on collateral (short-term interest rates).


We recently enhanced our CMAs to include alternatives, reflecting the increased use of this asset class in our portfolios. For alternative asset classes, we need to take a different approach to estimating returns, as the range of alternatives available runs the entire spectrum of risk. Long/short strategies, for example, behave differently than commodities, and both behave differently than global macro. And, for any alternative category, it can be a challenge to know how much of the return is true, uncorrelated alpha, and how much can be attributed to broad market exposures (e.g., the S&P 500 Index).

To estimate returns, we therefore construct linear models using available market indices from our traditional asset-class CMAs, and measure the proportion of the estimated returns and volatility that are attributable them.

Our outlook is for slightly higher (30 to 40 basis points) estimated returns over the next 10 years for non-directional alternatives due to higher observed beta to fixed income as well as higher equity-return expectations.

Five-year time horizon

In addition to adding alternatives, we recently expanded the time horizon of our CMA platform. Originally, our views were based on a 10-year outlook. Now, we also include a shorter five-year time horizon, facilitating our efforts to actively position our portfolios within the business cycle.

While still drawing on the building-block approach that underpins the 10-year time horizon, the methodology for the five-year time horizon incorporates estimating elements that are appropriate for understanding the behaviour of asset classes over a shorter holding period. That is, while the building blocks for estimating equity returns for a five-year time horizon are generally the same as those identified for the 10-year time horizon, their definition may change to better reflect shorter-term market dynamics.

Our view is that over the five-year time horizon valuations remain elevated, resulting in a more significant “haircut” in returns versus our 10-year expectations. In our view, the recent earnings growth trend is a non-factor right now (in terms of our forecast of 10 years versus five years), indicating that the U.S. economy is at limited risk of overheating in the near term.

Key takeaway

Our CMAs form a comprehensive platform that is not only integral to the construction of multi-asset portfolios, they are also designed to keep investors informed and engaged in the markets, forging sustainable long-term partnerships.

Institutional Investors: For additional information on the CMA methodology and the most recent estimates, please see Capital market assumptions: Methodology update.

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Important Information

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest-rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax and other regulatory and market developments.

Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money.

Yield is the income return on an investment.

Valuation is how the market measures the worth of a company or investment.

Roll return is generated when expiring futures contracts are replaced with new contracts.

The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest-rate changes and economic activity.

Credit spread (bonds) is the difference in yield between bonds of similar maturity but with different credit quality.

Roll yield is generated by rolling a maturing futures contract to a later-dated futures contract.

Invesco’s Duy Nguyen and Jacob Borbidge provide their outlook across asset classes, revealing how it informs their portfolios.