Capital Market Assumptions (as of December 31, 2019)

Market strength and the impact on our return assumptions

Keeping 2019 in perspective

Growing concerns over recession risks had rattled equity markets late in 2018 while depressing government bond yields. At the start of 2019, few would have expected equities and bonds to post strong double-digit returns for the year to come. Yet they did just that. Galvanized by massive global interest rate cuts and greater central bank liquidity injections which put recession risks in the shade, equity markets rallied strongly and were able to effectively combat significant headwinds in the form of escalating trade conflict between the U.S. and China, a rapid freeze in global trade and a deepening global economic slowdown. The S&P 500 returned some in 2019, but other equity markets were not outdone by much.

Furthermore, other asset classes beyond equities delivered strongly too. Demonstrating that this was no ordinary market rally was what happened at the other end of the risk spectrum to equities. Government bonds defied conventional wisdom and produced strong returns too, some of the best risk-adjusted returns in the markets (the US long-duration government bond index delivered almost 15%). The same rang true for gold, a ‘traditional safe-haven’, which returned about 18% in the year.

Of course, a moment spent looking behind the numbers shows that taking an arbitrary window like a calendar year can hide the underlying picture. 2018 had been a turbulent year and finished with a big sell-off, so some part of 2019 strength was part relief-rebound. Therefore, taking 2018-19 together shows a rather different picture to just looking at last year in isolation – global equity indices doing about 5% per annum over the two-year period instead of the gain five times larger that appears from looking at last year alone. All that said, the 2019 gains were impressive.

Pre-eminent though the US Federal Reserve’s three rate cuts last year were in market impact terms, the monetary easing trend went far wider. Focusing on G20 economies, the 2018 trend towards rate rises completely reversed in 2019, with most central banks moving to cut rates (see chart). After such a difficult 2018, this was healing balm to all asset classes, a central bank Midas touch in action not seen on this scale since the aggressive monetary response to the 2008 financial crisis. It revived spirits in very risky and troubled asset markets like equities and high yield, easing fears of global recession. But it energised bond bulls too, who anchored low yield expectations to lower central bank rates and a view that lower rates were more likely to persist.

How do these market movements affect our long-term return expectations?

As we discuss throughout this paper and reflecting an essential attribute of the way we construct our capital market assumptions, the price that you pay today for an investment will have a strong bearing on expected future returns. Significant market appreciation in 2019 has led to lower return expectations across the board across the asset class spectrum. We show the impact on a stylised "balanced" portfolio that only contains 60% U.S. equities and the remaining 40% invested in U.S. long-duration fixed-interest government bonds. With our volatility and correlation assumptions unchanged since 2018, the impact on the U.S. equity-bond frontier calculated using our assumptions is driven purely by the change in return expectations. This is the cause of the downward shift since 2018.

This, however, is not simply a one-year phenomenon. Though equities and risky assets have had some setbacks on the way, by and large, they have had a very successful decade. So, have bonds and so called ‘safe assets’. The upshot of that has been falling expected returns in such a balanced portfolio setting. Seen this way, 2019 was merely a good and strong example of this long-term trend in action, given the magnitude of market strength across the asset class spectrum. In fact, expected returns for such a balanced portfolio have been falling almost throughout the last decade.

To learn more, download the full whitepaper above.

^Disclaimer

^{This document has been produced by Aon’s Global Asset Allocation Team, a division of Aon plc and is appropriate solely for institutional investors. Nothing in this document should be treated as an authoritative statement of the law on any particular aspect or in any specific case. It should not be taken as financial advice and action should not be taken as a result of this document alone. Consultants will be pleased to answer questions on its contents but cannot give individual financial advice. Individuals are recommended to seek independent financial advice in respect of their own personal circumstances. The information contained herein is given as of the date hereof and does not purport to give information as of any other date. The delivery at any time shall not, under any circumstances, create any implication that there has been a change in the information set forth herein since the date hereof or any obligation to update or provide amendments hereto. The information contained herein is derived from proprietary and non-proprietary sources deemed by Aon to be reliable and are not necessarily all inclusive. Aon does not guarantee the accuracy or completeness of this information and cannot be held accountable for inaccurate data provided by third parties. Reliance upon information in this material is at the sole discretion of the reader.}

^{Past results are not indicative of future results. The tables and graphs included herein present expected returns, which are forward-looking expectations by AHIC based on informed historical results and internal analysis. These do not represent actual historical results. There can be no guarantee that any of these expected results will be achieved. The Capital Market Assumptions (CMAs) represents AHIC’s outlooks on capital markets and economies over the next 10 years. These views are constructed based on our framework of analyzing fundamental, valuation and long-term drivers of capital markets.}

^{Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. The views and strategies described may not be suitable for all investors. Opinions referenced are as of December 2019, and are subject to change due to changes in the market, economic conditions or changes in the legal and/or regulatory environment and may not necessarily come to pass. This information is provided for informational purposes only and should not be considered tax, legal, or investment advice.}

^{References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. This material is distributed for informational purposes only. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the information mentioned, and while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable.}

^{This document does not constitute an offer of securities or solicitation of any kind and may not be treated as such, i) in any jurisdiction where such an offer or solicitation is against the law; ii) to anyone to whom it is unlawful to make such an offer or solicitation; or iii) if the person making the offer or solicitation is not qualified to do so. If you are unsure as to whether the investment products and services described within this document are suitable for you, we strongly recommend that you seek professional advice from a financial adviser registered in the jurisdiction in which you reside. We have not considered the suitability and/or appropriateness of any investment you may wish to make with us. It is your responsibility to be aware of and to observe all applicable laws and regulations of any relevant jurisdiction, including the one in which you reside.}

^{Aon Limited is authorized and regulated by the Financial Conduct Authority. Registered in England & Wales No. 4396810. When distributed in the US, Aon Investment Consulting, Inc. (“AHIC”) is a registered investment adviser with the Securities and Exchange Commission (“SEC”). AHIC is a wholly owned, indirect subsidiary of Aon plc. In Canada, Aon Inc. and Aon Investment Management Inc. (“AHIM”) are indirect subsidiaries of Aon plc, a public company trading on the NYSE. Investment advice to Canadian investors is provided through AHIM, a portfolio manager, investment fund manager and exempt market dealer registered under applicable Canadian securities laws. Regional distribution and contact information is provided below. Contact your local Aon representative for contact information relevant to your local country if not included above.}

^{About Aon}

^{Investment advice and consulting services provided by Aon Hewitt Investment Consulting, Inc. (“AHIC”). The information contained herein is given as of the date hereof and does not purport to give information as of any other date. The delivery at any time shall not, under any circumstances, create any implication that there has been a change in the information set forth herein since the date hereof or any obligation to update or provide amendments hereto.}

^{This document is not intended to provide, and shall not be relied upon for, accounting, legal or tax advice or investment recommendations. Any accounting, legal, or taxation position described in this presentation is a general statement and shall only be used as a guide. It does not constitute accounting, legal, and tax advice and is based on AHIC’s understanding of current laws and interpretation.}

^{This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon AHIC’s preliminary analysis of publicly available information. The content of this document is made available on an “as is” basis, without warranty of any kind. AHIC disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. AHIC. reserves all rights to the content of this document. No part of this document may be reproduced, stored, or transmitted by any means without the express written consent of AHIC.}

^{Aon Hewitt Investment Consulting, Inc. is a federally registered investment advisor with the U.S. Securities and Exchange Commission. AHIC is also registered with the Commodity Futures Trading Commission as a commodity pool operator and a commodity trading advisor, and is a member of the National Futures Association. The AHIC ADV Form Part 2A disclosure statement is available upon written request to:

Aon Hewitt Investment Consulting, Inc.

200 E. Randolph Street

Suite 700

Chicago, IL 60601

ATTN: AHIC Compliance Officer}

^{© Aon plc 2020. All rights reserved.

The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.}

^{Aon Hewitt Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No: 4396810.

The Aon Centre

The Leadenhall Building

122 Leadenhall Street

London

EC4V 4AN}