Expected returns on a multi-asset portfolio

19 December 2022

In this note, we outline a framework for estimating expected returns on equities, government bonds, and corporate bonds. We combine estimates of expected returns across asset classes in developed markets to obtain the expected return on a multi-asset portfolio that approximates the benchmark index of the Government Pension Fund Global (GPFG).

Summary:

  • We outline a framework for estimating expected returns on equities, government bonds, and corporate bonds, which we apply to assets in the US, the euro area, Japan, and the UK. Across asset classes, we estimate expected returns as the sum of three components: income, cash flow growth and valuation changes.
  • Our approach emphasises the use of forward-looking data, combining market-implied expectations from traded assets and survey-based forecasts. This stands in contrast to other commonly used approaches, which tend to be based on historical returns and realised fundamentals. Forward-looking estimates of expected returns perform better than estimates based on historical returns, which can be biased and excessively volatile.
  • Focusing on long-horizon expected returns, our estimates indicate that expected returns were declining across asset classes between the Global Financial Crisis (2007-2009) and the outbreak of the Covid-19 pandemic. Since then, long-term expected returns have been increasing. As at the end of Q3 2022, expected real returns on equities and government bonds are estimated to be around 3.8 and 0.7 percent, respectively. Declining expected returns have predominantly been driven by falling real interest rates across developed markets. Risk premiums associated with exposure to equity and corporate bond markets have slightly increased and thus partially offset the decline driven by real rates.
  • We combine estimates across asset classes to obtain the expected return on a portfolio that approximates the benchmark index of the Government Pension Fund Global (GPFG). The expected real return on this multi-asset portfolio has been declining over the last decade, with part of the decline reversing in the post-Covid-19 period, reaching 3 percent at the end of Q3 2022. It should be emphasised that our estimates are uncertain and can vary substantially over time.

Download the discussion note (pdf)