CAMERA: our capital market assumptions update

The below is an extract from our Q4 Asset Allocation Outlook.

Earlier this year, we introduced CAMERA, our capital market assumptions framework. CAMERA combines two sources of return expectations – those from an equilibrium model that is primarily risk-based, and those from a model that is primarily valuation-based – to form a sensible blend of expected returns over a range of time horizons. The framework is based on the premise that in the long run, expected returns should converge to some equilibrium level, while over shorter horizons we may expect some deviation from equilibrium assumptions as a function of market valuations.

Of the regional equity markets included in our framework, emerging markets have the highest expected returns over both medium- and long-term horizons. It is perhaps unsurprising that there is also a high degree of uncertainty around those estimates, particularly over shorter horizons. We measure uncertainty both in terms of volatility, meaning fluctuations in asset prices, and parameter uncertainty, meaning the degree to which we can have confidence in the accuracy of our model inputs.

Fixed income asset return assumptions tend to have lower uncertainty associated with them than equity assumptions, both in terms of volatility and parameter uncertainty, and that is also true of emerging market debt (EMD). Interestingly, although there are only small differences between medium- and long-term return estimates for EMD, for local currency EMD we see medium-term expected returns lower than in equilibrium (i.e. an upward sloping CAMERA term structure) whereas for hard currency (US dollar) EMD we see medium-term expected returns slightly higher than in equilibrium. This is consistent with our short to medium-term asset-class views, where we have a positive view for hard currency EMD but a neutral view for local currency EMD.

The above is an extract from our Q4 Asset Allocation Outlook.