(Bloomberg) - AQR Capital Management is taking the ax to return projections for markets around the globe -- yet again -- while touting fresh strategies from commodities to leverage to salvage investment performance.
The quantitative manager co-founded by Cliff Asness is back with its annual capital-markets outlook, cutting expectations for asset gains in everything from U.S. equities, Treasuries and credit to developed-market stocks and global 60/40 portfolios.
All that means institutional investors need to smarten up with their risk-taking in the low-return era, according to the Greenwich, Connecticut-based asset manager. Recommendations include leveraging bonds and adding commodity exposure through derivatives, as well as allocating to hedge fund-like trades known as liquid alternatives.
“These diversifying steps raise the expected real return from 2% to almost 4%, at a similar level of risk,” the AQR team wrote. “To achieve 5% real return in this environment, investors may have to accept a higher level of risk.”
The Friday report comes amid a new year cross-asset selloff that’s been roiling Wall Street. With interest rates set to rise, the outlook for a traditional portfolio that invests 60% in equities and 40% in bonds looks underwhelming thanks to rich valuations. Rampant price growth has also curbed inflation-adjusted returns.
AQR has trimmed its real-return expectation for U.S. stocks in the next five to 10 years to 3.6% from 3.8%. The firm sees returns on American investment grade credit at 0.4%, down from 0.6%. High-yield expectations are reduced to 0.3% from 0.4%. The anticipated return on Treasuries drops to -0.8% from -0.5%.
The expected return for a global 60/40 portfolio is cut to 1.9% from 2.1%.
Investors should consider shifting half of the 60% equity portion of portfolios to a defensive stance, which can maintain returns while reducing risk, says the quant manager. A 10% commodity allocation, in the form of a derivatives overlay, would help in inflationary scenarios. It also touts “modest” leverage in bond allocations.
“The alternative is to increase savings and accept lower returns for their investments,” the firm said. “These unpalatable choices may be an unavoidable consequence of pervasive low riskless real rates.”
As ever, the AQR assumptions come with a warning: Projections are “highly uncertain, and not intended for market timing,” the report said. In previous years, the firm’s capital-market assumptions have proved too conservative thanks to the relentless stock and bond rally that sent valuations soaring.
“Maybe the next 10 years will see a continuation of the recent golden era for traditional portfolios, with all the inputs to our return estimates once again surprising on the upside, and we’ll be writing another mea culpa in 2032,” AQR said. “But we wouldn’t bet on it.”
By Sonali Basak
