Assets returns over the long run
To make informed choices, medium or long-term investors should estimate the prospective returns and risks offered by potential investments. If these investors do not harbor strong views on short-term prospects in financial markets, these expected returns and the associated risks provide an anchor for a value-oriented asset allocation with a long-term horizon. They determine what is often called the « strategic allocation ».
The evaluation of prospective returns is a difficult task. Clearly, one needs more than a mere extrapolation of past returns. Past returns are unreliable indicators because key economic variables have changed significantly over the past decades (e.g. inflation, public debt or the structure and the financing of retirement schemes). In addition, as investors experience spells of euphoria and depression, their risk aversion is unstable and asset prices experience large swings. For instance, it was certainly unreasonable to assume in 2002 that equities would keep appreciating as fast as they had during the Internet bubble.
For the main asset classes, DPA Invest has built tools to estimate their prospective returns on a 10-year horizon. All these tools share a common approach: they combine a medium-term scenario for key economic variables (e.g. inflation, short rates and profits) with fundamental valuation models derived from modern Finance theory (Gordon-Shapiro model for equities, yield-curve models for bonds, overshooting model for currencies).
