Parala's approach is straightforward and intuitive but one which requires highly complex and proprietary calculations to execute effectively. We've found that a simple way of expressing changes in expected investment outcomes is to use heatmaps. The heatmap below covers nine major asset classes. It shows a three-month ahead view of expected performance from May 2018 as well as the previous forecasts over the last year. The investor currency for expected returns is GBP and assumes that fixed income investments are currency hedged. Forecasts are updated each month with the latest macro-economic and risk factor changes.
What is our model telling us about key developments across asset classes for the coming months? A good place to start is considering some of the key macro trends that we have recently observed:
- USD currency has declined on a year-over-year basis against major trading partners but strengthened in recent months.
- Short term interest rates continued to rise which is negative for fixed term assets.
- Economic growth is positive as indicated by year over year increases in commodities.
- The yield curve has flattened and may be indicative of broader investor concerns.
- Equity volatility measured by the VIX Index declined following three months of rising volatility which may indicate investors are more sanguine about near-term equity risks.
A nice thing about the table is that it can be used to assess the relative attractiveness of different asset classes at a point in time as well as trends in individual asset class expectations across time with the more attractive potential returns moving from red to green.
So, what are the observable trends and what might we expect in terms of asset class relative returns over the next three months?
Here are some takeaways:
- Diversified commodities have the most favourable ranking over the coming 3-months followed by emerging market equities.
- Among fixed income asset classes, EM bonds have the most favourable ranking and corporate bonds the least favourable.
- Cash equivalents are the least favourable area to invest followed by corporate bonds.
What are the key market movers and what can we expect from equity markets over the coming three months?
- EM equities have the most favourable ranking over the coming three months followed by Asia ex-Japan equities.
- European small caps have the least favourable ranking from by UK large caps.
- UK large caps have fallen the most in the rankings since last month and UK small caps have shown the most improvement.
- Small caps are more influenced by changing domestic business conditions than international ones which may make UK smaller companies less affected by the uncertainty of Brexit compared to larger UK companies.