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This podcast is only for the attention of professional investors in the financial industry. Outerblue by Amundi. Welcome to Outerblue Talks Research, knowledge sharing on financial research.
- Giulio Lombardo
Hello and welcome to this Amundi Research Podcast. I'm Giulio Lombardo, Publishing Specialist at the Amundi Investment Institute, and in today's podcast we'll be talking about our annual Capital Market Assumptions publication. The report came out recently and covers how big transformative trends combined with a robust quantitative framework are affecting Amundi's expectations for long-term returns for over 40 asset classes globally. Joining me today to discuss our main findings are Monica Defend, Head of the Amundi Investment Institute. Monica, great to have you.
- Monica Defend
Thank you.
- Giulio Lombardo
and John O'Toole, Head of multi-asset investment solutions at Amundi. Thank you for joining us today, John.
- John O'Toole
Thank you.
- Giulio Lombardo
So without further ado, Monica, let's perhaps start by explaining to our listeners what it is we set out to do in our capital market assumptions and what's new in this year's edition compared to the last.
- Monica Defend
Well, with the world economy that is rebalancing, if not rebooting, I would say that this year capital market assumptions are really trying to detect the game changers that are currently at play and seeing how this will spill over into the growth of the world economy and the expected returns assumption that we run this year over 40 asset classes. So we widened further the investment universe. We take into account three main long-term themes, starting from this increase in nationalism and geopolitical fragmentation. We consider the artificial intelligence and how this actual revolution on the technology side will have an impact on the global economies. And third, we also consider demographics. So, on one side, we have this silver economy in the developed market and the emerging market on the other side. So, we then have a key focus on Europe, on this transformative Europe that we all hope to see. And Asia, and in particular, India, that is not just the world's factory, but it's dynamic, resilient and is really presenting itself as an integrated economic power. So when compared to what we did last year in 2024, we revised a bit the long-term macro scenarios to factor in these changes that are taking place both on the social and economic side, including the climate transition, and last but not least, the impact of artificial intelligence.
- Giulio Lombardo
Thank you, Monica. So you touched upon some of the so-called spillovers from the main themes, which caused you to revisit the macro scenario, which sort of lays the foundation for your return forecasts. I wonder if you could tell us a little bit more about these, and particularly how they're affecting your long-term projections for growth and inflation globally.
- Monica Defend
Well, the starting point is to revisit to the socio-economic scenarios, which means basically taking into account regional rivalry and nationalism with all the nations that are prioritizing their domestic issues. This is an impact, as we are seeing now, on global cooperation and in particular this is providing rising inequalities. Investment in human capital is an event and this unfortunately is creating some disparities on the economic backdrop. The second major assumption and shift when compared to last year refers to the transition to net zero. Last week I was attending the IMF meeting and really climate seems to be out of fashion. So what we have been penciling in is a delayed and fragmented transition to net zero. That implies rising transition costs and therefore lowering the path when compared to last year. Third, the impact of the artificial intelligence. This was a component that we had last year as well, but this year we are really key focus at sector level, but we have been also delving at country level using the IMF prepared index to assess at country level what the potential gains on the productivity side we can experience. And then the elephant in the room, inflation dynamics. We have been talking for a while about the costs and inflation related to transition. There is much more now with this uncertainty on tariffs, and last but not least, on the long-term growth patterns. So we are starting with the idea of demographic trends and productivity gains that will drive the long-term growth with Asia that is somehow taking the leadership in particular on the technological sector, but 2025-2026 will clearly show and have an impact also on the long-term growth.
- Giulio Lombardo
As you said, this seems to be sort of a year in transition, so we'll see what foundations it will lay for the future. And I'd like to come back to some of the points you've touched on, but first let me turn to John. So in the context of the macroeconomic framework that Monica just described, what are the key 10-year expected return findings from this year's exercise, starting perhaps with the liquid asset classes?
- John O'Toole
Indeed, I mean, a more favorable growth inflation mix is anticipated, as Monica said. And we do expect overall expected returns rising to a median of around 6% across 23 different asset classes. That's up from about 5.5% last year, 2024. Increased uncertainty around inflation is expected to influence asset class behaviour, and particularly increasing bond volatility. If we think about risky asset classes, we reckon 70% are projected to deliver returns above 7%. And that is a significant increase on last year, where only 23% of risky asset classes were expected. Notable improvements are seen in private equity, in infrastructure, and in European equity, while only a few asset classes like Chinese bonds and European high-yield credit show lower returns. If we think about fixed income, expected returns of fixed income are slightly higher, with mixed effects across markets due to varying assumptions. Interest rate targets have been revised upwards for the US, for the EU and India, leading to higher cash rates. Whilst in the US, UK and Japan, government bond markets show improved returns. And again, that's due to favourable valuations, while EMU bonds remain unchanged. Emerging market debt is appealing with return expectations close to 6%, and that's the highest in fixed income. Coming to equities, I mean, equities, we expect benefit from improved EPS growth prospects, or earnings per share, with an average expected return increase of around 0.7% for the MSCI All Country World Index. Stronger earnings growth forecasts in developed markets are driving this improvement, particularly in Europe, which shows better earnings prospects and valuations. Emerging market equities also see improved returns, although India faces higher valuations compared to last year.
- Giulio Lombardo
Thanks, John. So, you've mentioned listed equity and fixed income markets. What about the prospects for real and alternative investments and how do they compare to their listed peers.
- John O'Toole
So, I mean, real, alternative assets, they show appealing risk reward profiles with the global private equity and private debt expected to outperform their liquid counterparts. Global private equity is projected to deliver slightly above 10% returns over the next decade. That's reflecting an increase of 1.5% or so from last year. And this is driven by revised public equity returns. The expected return for private equity is higher than public markets by 4% despite challenges from increased leverage costs. Manager selection, as we know, is critical as a significant percentage of funds historically underperform against liquid benchmarks. If we turn to global infrastructure, expected returns are around 7.9%, up from 7% last year, again, driven by higher equity returns and long-term demand for energy and data centre investments. Demographic trends such as urbanization, will further support infrastructure demand, particularly in emerging markets. Turning to real estate, returns are projected between 5.3% and 6% for European and US real estate respectively. Again, this is reflecting an improvement from last year in the order of 1.5%. Higher nominal GDP assumptions and a return to office culture are key factors driving this increase. Private debt is expected to yield around 7.3% over the next decade, benefiting from high interest rates and spreads. The illiquidity premium remains a significant driver of returns, particularly in the US market. And lastly, turning to hedge funds, I mean, we expect hedge funds to deliver returns slightly below 6% based on alternative risk premium cash contributions. The upward revision of real rates in the US provides tailwind for hedge fund returns with a similar risk profile to fixed income.
- Giulio Lombardo
Thank you, John. So, Monica, in opening, you mentioned that one of the key themes that emerged from this year's publication is Europe's transformation. And we've already seen this happening in the recent months with some of the latest political developments, like Germany's infrastructure and defence spending plan. How do you think the journey towards Europe's greater autonomy, higher competitiveness and innovation can drive opportunities for investors in the region?
- Monica Defend
Well, let's consider the starting point. So, the economic and security challenges. Europe is facing significant economic challenges. So, the starting point is insufficient investment, weakening productivity, ageing population, particularly in the Eurozone. And the US decision to reduce its military support for Europe compels EU member states to announce their defense capabilities. And this is exemplified by this decision that Germany has taken, deciding to increase the expenses in infrastructure and on defense. Second, we have been largely talking about the Draghi and Letta report. The European Commission is trying to translate actively what has been written by Draghi and Letta into actionable proposals to boost investment and competitiveness. The key measures include reducing regulatory burdens, supporting small and medium-sized enterprises, and enhancing energy independence through renewable energy development. But if we look more at the medium term, what is the scenario for Europe, the EU is expected to gradually improve in investment, innovation, and competitiveness. with a focus on encouraging innovation and productivity through regulatory reforms, strengthening capital market integration. And this was really a key topic during the IMF meetings. And this will allow really to better utilize and mobilize the savings that are quite abundant in Europe. And, last but not least, broadening the commercial partnership to reduce supply chain dependency. 2025 is a pivotal year. We see some initiatives on the plate. The European Commission is set to unveil concrete action plans, including the competitiveness compass that should reverse industrial decline and enhance competitiveness, in particular in the artificial intelligence and energy sector. The Clean Industrial Deal, which will mobilise over 100 billion euros to support the decarbonization and clean technology production and the white paper on defense and the ReArm Europe proposing measures to strengthen the defense sector and stimulate investment, potentially mobilizing near 800 billion euros over half four years. On the European equities outlook, what we have seen is since the beginning of the year, really some kind of rebalancing of investors out of U.S. asset into Europe in the broad sense. So, this is bonds, this is equities, this is the Euro. So, after a period of underperformance, European equities are beginning to show signs of recovery supported by improved valuations and anticipated gains from industrial policies. Projections indicate that European equities may up perform the global index over the next decade, bolstered by fiscal support in Germany and potential reconstruction effort in Ukraine. But there are also some long-term investment drivers, the combination of increased defense spending, infrastructure investment that is pivotal at this stage and the focus on innovation and sustainability positions, Europe has been attractive as an investment destination. The structural improvement in the European economy, alongside favourable policies, are expected to create significant investment opportunities across various sectors.
- Giulio Lombardo
So, talking about sectors, are there any particular ones both in Europe and globally, where you see the highest return prospects in the context of these ongoing developments, you know, geopolitical movements, artificial intelligence, and the other themes you've described for us?
- Monica Defend
Well, let's take as a reference the universe of the Morgan Stanley All-Country Index and the sector rankings that it's provided. I would say a mix of value and growth sectors is expected to prevail. Driven by these three themes you were mentioning, artificial intelligence, which implies a democratization of AI and the shift from "hyperscalers" to "enablers" in the software sectors that are expected to enhance global productivity and equity. IT remains a strong candidate for returns, though it is currently expensive in the US. It is more affordable in the emerging markets,. Other sectors, particularly healthcare. are also poised to benefit from AI advancements. On the second theme, climate change and geopolitics, energy, materials, staples are negatively impacted by climate change and ESG considerations, while utilities perform slightly better, but still underperform overall. Industrial, including aerospace and defense are expected to benefit from geopolitical dynamics with capital expenditure driving growth more than consumption. Last but not least, deregulation and policy support. Policy changes are set to support global financial sectors, different local regions. In the US, for example, deregulation will enhance capital efficiency, while in Japan, unbundling cross-shareholding will drive growth. In the Eurozone, high shareholder returns will benefit financials, which will also play a role in financing capex investment and improving efficiency through AI adoption.
- Giulio Lombardo
Thanks, Monica. Let me come back to you, John, because another of the key themes that emerged this year is the return of the importance of diversification as a key focus for investors. So from a multi-asset perspective, how can investors optimize their strategic asset allocation over the coming decades to prepare for these transformative changes ahead?
- John O'Toole
Sure. I mean, portfolio construction will certainly have to address multiple challenges coming from concentration risk, potential valuation resets in some areas, and also the high level of uncertainty and long-term rate dynamics. We have unstable correlations, also in an uncertain inflationary environment to contend with. These factors will increase the demand for portfolio construction diversifiers, as we believe. So, things like private debt, emerging market debt, and hedge funds. will be the favourite candidates in this space. In terms of return expectations, we expect Euro-based moderate risk investors can expect annual returns in the region of 4.4% to 4.9% with real alternative assets added. U.S. investors with a similar profile, we expect can anticipate returns of 5.6% to 6%, reflecting a 30 to 70 basis point increase from last year due to higher expected returns for for risky assets. When it comes to strategic asset allocation, global aggregate, that does remain a key pillar for strategic asset allocation, comprising around 47% to 51% of euro investors' allocations, and 50% to 54% for dollar investors, though its weight has decreased compared to last year. Allocation remains around 20%, 25% for opportunistic fixed income for both investor types, again, focusing on elements like global high yield and emerging market bonds. In terms of equity allocation, we would say it's increased, reaching 25% for euro profiles, primarily tilted toward developed markets, while slightly lower for emerging markets, due to the transition risks in US policies that Monica alluded to. Dollar portfolios have a lower equity allocation, around 21%, benefiting from hedging, foreign fixed income, and higher probability of outperforming inflation. Allocation to real and alternative assets is similar for both investor types, including private debt, private equity, and infrastructure. Exposure to private equity does enhance return potential, whilst income-like alternatives like private debt and infrastructure, they really optimize the risk-return profile. For aggressive risk profiles, return expectations increased by over 100 basis points, ranging from 5.6% to 6.2% for Euro investors, and around 6.8% to 7.3% for dollar investors, we estimate. Bond allocation remained about one-third of the total portfolio, with a greater preference for opportunistic fixed income. Global ag allocation decreases to 10%, 14% for dynamic investors, with a shift toward real and alternative assets, again funded by a reduction in developed market equities. So, we really think the inclusion of real and alternative assets, primarily private debt and equity, does improve the portfolio risk-reward balance. It controls tail risk, i t reduces the likelihood of underperforming inflation. Investors should be aware of the increased risks, obviously, associated with illiquidity and complexity in alternative investments, necessitating specific technical expertise.
- Giulio Lombardo
Monica, John, I'm afraid that's all we have time for today, but thank you so much for being with us and for your detailed insights into this year's capital market assumptions.
- Monica Defend
Thank you, Giolio. Thank you, all.
- John O'Toole
Thank you, Giolio. Thank you.
- Giulio Lombardo
And thank you all for tuning in. We hope you've enjoyed this special episode and that you'll join us again soon for another Outerblue Talks Research podcast.
- Disclaimer
This podcast is only for the attention of professional investors as defined in Directive 2014-65-EU, dated 15 May 2014, as amended from time to time on markets and financial instruments called MIFID II. Views are those of the author and not necessarily Amundi Asset Management SAS. They are subject to change and should not be relied upon as investment advice, as a security recommendation, or as an indication of trading for any Amundi products or any other security. Fun units or services. Past performance is not a guarantee or indicative of future results.
