Getting the most from equity allocations - J.P. Morgan Asset Management
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Getting the most from equity allocations

Contributor Patrik Schöwitz
Global diversification and active alpha generation can be antidotes to modest equity returns

Relative to historical norms, the long-term outlook for investment returns across asset classes is not inspiring—a reality driven largely by expectations for only modest global economic growth and generally low (but reasonably stable) inflation. That is the overriding message from J.P. Morgan Asset Management’s 2016 Long-Term Capital Market Assumptions, an internally consistent set of 10- to 15-year return, risk and correlation estimates for over 50 asset classes globally.

A modest outlook for global equity returns

Taking a closer look at equity markets, our return estimate (in local currency terms) for developed market (DM) equities is a disappointing 6.75%, attributable to still elevated valuations and modest expectations for economic and hence, earnings growth rates.

Our estimate for emerging market (EM) equities is 9.75%, reflecting more attractive valuations and stronger growth rates for emerging vs. developed markets. This expected 300bps spread is roughly in line with the average over the last 30 years, but still underwhelming, given that it follows almost five years of EM underperformance.

U.S. dollar (USD)-based investors in EM equities should benefit if the dollar retreats over the long run following its strong appreciation during the course of 2015 (and into 2016)—an assumption reflected in our 10.0% USD-based EM equity return estimate. A reversal of USD strength would mean local currency returns could be converted back to more dollars. Globally divergent monetary policies, however, are likely to add to currency and market volatility in the near term.

Our modest return outlook for global equity markets, together with expectations for globally divergent monetary policies suggest that diversification and less benchmark-constrained portfolio management can be more important than ever in managing risk and closing the gap between the returns investors need and what they can expect from market (i.e., beta) returns alone.

Equities—a differentiated view

Getting the most from equity allocations involves more than strategically allocating between just the broad DM and EM equity categories. In estimating long-term returns for individual developed and emerging equity markets, we consider contributions from revenue growth (and its global composition), profit margins, share buybacks and dilution, valuations and dividends. As seen in Exhibit 1, within and among developed and emerging markets, there are important differences in both the drivers and composition of returns. To pick an example, margins, as they normalize from peak levels, are expected to be a negative for the U.S., while improving margins should be a positive for European and UK returns. To pick another, payouts to shareholders will likely be a more important driver of returns in the U.S. than in most other developed markets, and will generally be a less important driver in emerging markets. Within emerging markets, China and Taiwan, at the cheap end of the spectrum, should see expanding price multiples contribute positively to returns, while at the expensive end, prices relative to earnings should be a strong detractor.

These differences across markets illustrate how diversification can be a critical risk management tool for equity investors, while active allocation can help enhance returns. Of course, differentiation also exists within country and regional markets and by sector. For a value-oriented investor who understands fundamentals, this differentiation is a source of alpha opportunities.

Investment Implications

With a long-term outlook characterized by divergent monetary policies and different starting points for valuations, economic growth and corporate earnings, equity investors need to remain diversified across DM and EM markets, as well as by regions, countries and sectors within these markets. Those able to actively move among and within global equity markets to identify opportunities, while managing currency risk, can still earn attractive risk-adjusted rewards from their equity allocations—and narrow the gap between needed returns and the historically lower returns that can realistically be expected in a world of only modest economic growth.


International investing bears greater risk due to social, economic, regulatory and political instability in countries in "emerging markets." This makes emerging market securities more volatile and less liquid developed market securities. Changes in exchange rates and differences in accounting and taxation policies outside the U.S. can also affect returns. Diversification does not guarantee investment returns and does not eliminate the risk of loss. Diversification among investment options and asset classes may help to reduce overall volatility.