JP Morgan Asset Management recently published the 20th anniversary edition of its Long-Term Capital Market Assumptions. Said to include “time-tested projections to build resilient portfolios,” the comprehensive 84-page document provides risk and return projections for approximately fifty asset classes, along with cross-asset correlations for the entire data set. Its section on alternatives considers hedge funds, private equity, real estate, infrastructure, and commodities.
Higher public equity returns since 2009 are setting the stage for below-average returns in the coming years. Public equity is still the dominant factor in overall hedge-fund returns, and thus, JP Morgan expects hedge funds to face challenges over the near-term. The environment for alpha generation remains difficult, but should improve over the intermediate term.
Ultimately, JP Morgan is most bullish on event-driven funds, for which it projects long-term returns of 6.00%. The firm anticipates 5.50% returns for equity long-bias strategies, 5.25% for relative value, 5.00% for macro, and 4.25% for so-called “diversified” hedge funds.
Private equity (“PE”) looks more attractive by comparison. The years of higher public equity returns should have a positive impact on PE returns going forward. JP Morgan anticipates a “modest premium” for PE over public equity, due to the “downward drift in alpha” and an expected “net-negative” impact on public equity from secular trends.
JP Morgan has increased its expected long-term capital market returns assumption for private equity from 7.75% to 8.5%, primarily due to rising return assumptions for U.S. mid-cap and European funds.
JP Morgan says the real estate cycle is “aging gracefully.” A recent run-up in property values has brought real estate closer to fair value, thereby causing JP Morgan to lower its return estimates for the asset class, but real estate should still offer attractive returns relative to stocks and bonds, in the firm’s view. JP Morgan expects real estate valuations to continue to rise.
JP Morgan breaks down its coverage of real estate into direct and indirect halves. The direct half is further subdivided into “U.S. core” and “European core” groups, each with expected long-term returns of 5.5%; while the indirect half includes U.S., European, and REIT groups, with respective anticipated long-term returns of 6.00%, 8.25%, and 7.25%.
Meanwhile, the low-yield environment will stoke demand for infrastructure investments, under JP Morgan’s forecast. “Non-trophy, midmarket assets” should provide the best opportunities for liability-driven investors and others in pursuit of yield. Nevertheless, JP Morgan says the following factors are “likely to dampen returns somewhat:”
- The rise of asset prices in 2015, which has reduced potential forward returns, particularly for super-core or trophy assets;
- Regulation over the next 3-7 years is likely to constrain utility-sector returns; and
- Debt costs are expected to rise.
As a result, JP Morgan scaled back its long-term return assumptions for infrastructure by 0.25% compared to 2015’s estimates, to 6.50%.
Sluggish demand from China has spilled over into other emerging markets, and JP Morgan thinks we’re “still in the early innings” of the “demand/supply readjustment process.” Ultimately, commodity prices have to rise in JP Morgan’s view, since prices at current levels are insufficient to incentivize the production necessary to meet long-term demand. But over the nearer term, the firm sees gold returning 3.50%, down from an estimate of 4.00% in 2015; and other commodities returning 3.00%, down from a previous estimate of 3.50%.
“Beta drivers vary across alternative strategies,” according to Anthony Werley, Chief Portfolio Strategist of JP Morgan’s Endowment and Foundations Group, and for this reason, “manager selection remains critical to success.” Alternatives can’t be considered as a monolithic group – and with the comprehensiveness of JP Morgan’s paper, readers face no danger of making that mistake.
For more information, download a pdf copy of the paper.