AQR Says to Get Sober About Future Returns

Cliff Asness’s firm doesn’t want investors to get excited. AQR expects the real return of a U.S. portfolio divvied up 60 percent in stocks and 40 percent in bonds to be 2.4 percent. That’s around half its long-term average of nearly 5 percent since 1900.

“The year 2019 saw a reverse of 2018’s cheapening, with expected returns falling for both equities and (especially) bonds,” according to the firm’s capital market assumptions for major asset classes, published Wednesday. The firm’s research focuses on medium-term expected returns — over five to 10 years — and updates the forecast annually. All of AQR’s estimates are lower than last year because of increased asset prices in 2019. 

The firm says the results aren’t surprising, particularly given low yields that have persisted for years. What investors earn on cash influences every other investment result. Central banks around the world have kept rates extraordinarily low for a decade, a policy that has altered market fundamentals. 

“We should not be surprised that many long-only investments have low expected returns today. In theory, all assets are priced according to the present value of their expected cash flows. The riskless yield is the common component of all assets’ discount rates, and when it is lower than historical averages it tends to make all assets expensive,” AQR’s latest study said.

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In AQR’s analysis of alternative risk premia, it argues that aggregate valuations of multiple style factors like value and momentum are near long-term averages. 

“Among equity styles, defensive and momentum styles are mildly rich by some measures, while value has been looking increasingly cheap,” wrote the study’s authors. “Our research suggests there is only a weak link between the value spreads of style factors and their future returns, making it difficult to use tactical timing based on valuations to outperform a strategic multi-style portfolio.” 

But the alternatives firm believes that last year some value factors became cheap enough to earn an overweight in multi-factor strategies. 

Even though data is less available on illiquid assets like private equity and real estate, AQR started modeling expectations for these asset classes last year. 

Using the average of two different frameworks, AQR estimates a 4.3 percent net-of-fee return for private equity. That compares to AQR’s expected 4 percent returns for U.S. large-cap equity. AQR expects 3 percent returns for un-levered real estate.

“As of January 2020, these estimates are soberingly low,” concluded AQR. “They suggest that over the next decade, many investors may struggle to meet return objectives anchored to a rosier past. Low expected cash returns are one clear culprit, dragging down expected total returns on all risky investments.”