As we finally settle into 2023, our wish is simple: farewell 2022 – and never come back! After 40 years of attrition and incursion into negative territory, a rise in interest rates was universally expected, but the speed and violence of the retracement surprised even the most seasoned investor.

In 2022, portfolio performance was not proportional to risk but was instead unanimously down and by a similar magnitude. Indeed, when low-risk bonds lose as much as riskier equities, all portfolios are hit in the same way.

However, as we foresee no recession at this stage, there is good news: the resulting declines in market value have mechanically increased risk premiums, and higher interest rates have pushed yield above inflation. So now is the time to position your portfolio for 2023, close to your Strategic Asset Allocation (SAA).

What are our Capital Market Assumptions?

Let’s now look at our ‘CMAs’ – our capital market assumptions. These are the risks and returns that we expect over the next ten years for asset and sub-asset classes. We use the observable yield of government bonds (i.e. the ‘risk-free’ rate) as our base layer and then add on an appropriate risk premium for each asset class in a layered approach.

1. Cash

With regard to cash (or money markets), our expected return is directly derived from government bonds, using the short end of their curves as the basis. 

2. Bonds

For corporate bonds, our ten-year expected return (annualised) lies at 3.8%. The expected return of high-yield bonds is 6.8%.

3. Equities

For equities, overall, since simple equity risk premiums (earnings yield minus government bond yields) are stable, with higher interest rates making up for lower P/Es (price to earnings ratio), we have kept the equity risk premium at its average long-term value of 4%.

4. Real estate investment trusts (REITs)

REITS are unchanged at a 3.5% annualised risk premium over the next ten years. For Swiss real estate funds, however, we increased the risk premium by 0.3% to 2.3% after the market downturn pushed dividend yields higher and agios (or surcharge) lower.

5. Alternative investments

For alternative investments (i.e. hedge funds in our portfolios), we have left the risk premium at its historical average of 1.5%, which is commensurate with corporate and high-yield bonds, as the volatility of these asset classes is comparable.

6. Gold

We have also made no changes regarding gold, an asset that provides insurance value in times of crisis, since we consider it to be fairly priced in the absence of systemic risk. Thus, we calculate a zero risk premium for gold over government bonds.

7. Private equity

Finally, and as usual, private equity exhibits the highest expected return, 2.5% above equities, which is in turn 6.5% above government bonds.

What does this mean for returns?

With these higher expected government bond yields as our base, and generally stable risk premia, our expected returns for most asset and sub-asset classes are now much higher than last year, even pushing them above the level of inflation, which thus provides an escape from financial repression.

For the full deep-dive, download our Asset Allocation Perspectives brochure below.