Cliff Asness: Get Your Expectations in Line With Reality

In this article, AQR assess the assumption built into today’s market and what that likely will mean for forward returns. These insights aim to guide investors in setting realistic medium-term (5-10 years) expectations while emphasizing the importance of valuation discipline and diversification in navigating compressed risk premia across asset classes.

Here are the key take-aways:

• Medium-Term Expected Returns: A global 60/40 portfolio (60% equities, 40% bonds) is projected to deliver a real return of 3.5%, an improvement from the 2021 low of 2% but still below the long-term U.S. average of nearly 5%. Equity returns remain compressed due to high valuations, with U.S. equities expected to underperform other developed markets due to richer valuations and lower risk premia.

• Government Bonds and Credit Markets: Bond yields have risen significantly since their historic lows in 2021, offering positive real returns across most major markets. U.S. 10-year Treasuries are expected to deliver a 2.5% real return. Credit markets, including investment-grade and high-yield bonds, show improved expected returns due to higher Treasury yields and better rolldown effects, with U.S. corporate high-yield bonds projected at a real return of 3.5%.

• Growth Expectations and Equity Valuations: U.S. corporate earnings growth has been robust historically but is projected to moderate to around 2% annually over the long term. Current U.S. equity valuations imply overly optimistic growth expectations, with the market pricing in growth rates significantly higher than AQR’s assumptions.

• Diversification and Tactical Adjustments: Broad diversification across asset classes and regions remains critical for long-term portfolio resilience. While some tactical opportunities (e.g., equity value style) have normalized, maintaining exposure to diversified factors is recommended given the uncertainty in market conditions.