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Fundamental drivers of asset returns

17 December 2021

In this note, we decompose equity and bond returns into their fundamental drivers based on expected cash flows, inflation, real interest rates and risk premiums.


  • Asset returns are driven by changes to their expected future cash flows and the corresponding discount rates. In this note, we use this idea to identify the fundamental drivers of equity and bond returns based on expected cash flows, expected inflation, real interest rates and asset-specific risk premiums.
  • Certain fundamental drivers are common across equities and bonds, most importantly real interest rates. The level of real interest rates is a key driver of the long-run returns on multi-asset portfolios, in large part due to the long duration of equities. To accurately capture the economic forces driving real rates, our decomposition splits real rates into a transitory component, dominated by the monetary policy cycle, and a persistent component that reflects secular developments in the economy.
  • We use our framework to examine the properties of fundamental drivers of equity and bond returns over the last few decades, where the real rate components have played a significant role. In addition, we highlight the fundamental drivers during 2020 – a year dominated by the global pandemic and the subsequent policy response to it. The large drop in equity prices in the first quarter was caused by both lower cash flow expectations and a sharp increase in the equity risk premium. The fall in equity prices was partly offset by a combination of easier monetary policy and a decline in the persistent component of real rates.

Download the discussion note (pdf)