Even financial experts agree: return forecasts are subject to great uncertainty. Traditional strategic asset allocation often starts with this most difficult part, the point forecast for the various asset classes. In our approach, we deliberately take the opposite path.
This leads to more robust return forecasts and a more balanced investment strategy. Our sound return forecasts are the natural result of the risk model (see first article) and the substantiated market opinion (see second article). Economically speaking, our return forecast is the compensation for the risk taken. This derivation also allows us to coordinate the decisions made for the risk model and the market opinion.
Risk model and optimal weighting as inputs
In order for us to derive the expected economic return, we need the risk and the optimal weighting. We estimate the risk for the future with our factor risk model, which comprises nine risk factors.
We start with a neutral portfolio for the optimal weighting. The market-weighted portfolio of the asset classes, also known as the market portfolio, is suitable for this purpose. It represents the portfolio held by an average investor. We adjust this with an average Swiss home bias. Local investors typically hold a higher proportion of Swiss equities and bonds. We apply our underweights and overweights from the substantiated market opinions to this market portfolio with a "Swiss finish" and thereby obtain the optimal portfolio for Swiss investors.
Robust expected returns as the output
Knowing the risk model and the optimal weighting, we can derive the expected returns per asset class. From an economic standpoint, the expected return of an asset class increases with greater risk and correlation to the market (see figure below). Both factors increase book losses in the event of a correction.
Moreover, as a rule, the higher the share of an asset class in the optimal portfolio, the higher the required return to compensate for the risk. This implicit derivation guarantees consistent compensation for the risk in the portfolio context for the expected return.