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Capital Market Assumptions

Wells Fargo Investment Institute - July 2019

Presenter: Veronica Willis, Investment Strategy Analyst, Wells Fargo Investment Institute

Transcript: Capital Market Assumptions

Title graphic: Capital Market Assumptions

Developing an investment plan can help investors meet their financial goals that occur at different stages of their lives. These goals can be immediate, short term, or long term and therefore, when constructing a plan, it’s important to differentiate between what’s happening in financial markets today, what is likely to happen tomorrow, and what may happen farther in the future.

Capital market assumptions, or CMAs, provide what we believe are reasonable expectations for asset class performance over the next 10 to 15 years. CMAs are long-term averages designed to reflect what investors may experience through at least one full economic and market cycle. A full market cycle would include periods of time when financial markets are likely to rise and fall as the economy expands and contracts. Our CMAs take historical relationships into consideration, but don’t necessarily assume the future will play out exactly like the past. Keep in mind CMA returns are not promises of actual returns or performance that may be realized. They are based on our estimates and assumptions that may or may not occur in the future.

CMAs are the foundation for the strategic asset allocation models that investment professionals use for long-term investment planning.

Title graphic: Developing Our 2019-2020 CMAs

When we develop capital market assumptions, we consider long-term themes, looking out 10 to 15 years. This year, six prominent global investment trends helped shape our strategic view:

  • First – We expect inflation to be lower than long-term averages, but above current levels.
  • Second – We see interest rates normalizing to accommodate modest economic growth and moderate inflation.
  • Third – We expect higher volatility in capital markets and lower-than-historical total returns for many asset classes.
  • Fourth – We think the risk reward trade off in emerging-markets will improve as the region’s markets mature.
  • Fifth – We believe commodity-price gains are likely to be modest as supply and demand balance.
  • And finally – For qualified investors, private alternative investments may play an important role in improving the risk adjusted returns of a diversified portfolio.

Title graphic: Investor Implications

Wells Fargo Investment Institute uses our asset class CMAs to help develop strategic asset allocation recommendations for globally diversified portfolios that take into account an investor’s goals and risk tolerance.

  • We are leaning towards U.S. assets in our fixed income and equity allocations
  • We are also including allocations to private alternative investments for qualified investors that may improve risk-adjusted return expectations
  • We are eliminating allocations to Developed Market ex-US bonds, public real estate and commodities; and reallocating to U.S. fixed income and global equities. We are maintaining a modest public real estate sector exposure through global equity allocations. Commodities were removed given the overall small allocation and the persistent bear market supercycle that we believe will continue for several more years. Meanwhile, we believe Developed Market bonds will likely suffer long-term headwinds from a low rate environment.

And finally, it is important for investors to maintain a well-diversified portfolio of assets to help manage volatility and take advantage of evolving long-term opportunities. Comparing the risk and return characteristics of various asset allocations may help investors choose the portfolio mix that best suits their individual needs.

Risk Factors

Alternative investments are not suitable for all investors and are only open to “accredited” or “qualified” investors within the meaning of the U.S. securities laws. They are speculative, highly illiquid, and are designed for long-term investment, and not as trading vehicles.

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Alternative investments trade in diverse complex strategies that are affected in different ways and at different times by changing market conditions. Strategies may, at times, be out of market favor for considerable periods with adverse consequences for the investor.

Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions. Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

Diversification cannot eliminate the risk of fluctuating prices and uncertain returns.