Investing in equities in the past decade has been a challenging, delivering a low return, with a very high risk. This fact has increased pressure on managers of equity and balanced portfolios to deliver positive returns to clients who are frustrated seeing their assets unchanged or declining.
A similar market pattern dominated from 1968 to around 1980. Since then, economic explanations have been developed to attribute the corporate underperformance during that period. We are certain that a solid economic rationale will be developed to explain current underperformance as well. Factors such as excessive borrowing, demographic trends, and an income inequality that suppresses aggregate demand are already being presented as potential explanations.
S&P 500 Index, 1950 – 2011
But, even if economic trends are perfectly understood, that still doesn’t help investment managers outperform their mandates. Since 2000, the S&P 500 has reached peaks of around 1500, and troughs of around 800 (and even lower in 2008) – declines of over 40%!
So, what is an investment manager to do?
To outperform, managers must adjust their asset exposures dynamically, through tactical asset allocation strategies. To do this successfully, they need to forecast near-term returns for equity indices and for other asset classes (bonds, commodities), with reasonable accuracy. For example, equity markets have been strong so far in 2012, but will it continue? Developing such return forecasts is critical to the correct asset mix positioning.