All Asset All Access

All Asset All Access: Long‑Term Forecasts Help Identify Compelling Investments Today

Research Affiliates discusses the methods underpinning long-term return forecasts and the attractive opportunities we see in value stocks today.

Founder and chairman of Research Affiliates, Rob Arnott, discusses how the firm assesses attractive return opportunities and the role of the All Asset strategies in portfolios. Jim Masturzo, partner and head of asset allocation research of Research Affiliates, explains why the firm believes value-oriented stocks remain compelling and how the All Asset strategies are positioned to benefit. As always, their insights are in the context of the PIMCO All Asset and All Asset All Authority funds. All Asset All Access is published quarterly.

Q: Let’s start with your approach to identifying market return opportunities. How do you research and estimate long-term market return forecasts?

Arnott: Conceptually, any investment can produce returns in three ways: income, growth (or deterioration) in income, and changes in valuation levels (or yields for bonds). At Research Affiliates, our models use these three building blocks to derive long-term buy-and-hold asset class return forecasts. For any investment or index, we know the current yield, and we know the long-term historical growth in income (typically zero for fixed income, inflation-plus for stocks, negative for high yield bonds with occasional defaults). Absent any change in valuation multiples or yields, those are the building blocks of the long-term return. In our forecasting approach, we then include a mild nod to mean reversion: Valuation multiples, yields, and spreads have shown a powerful tendency to eventually mean-revert toward historical norms. However, since mean reversion is somewhat unpredictable, our models only assume partial mean reversion – spread out over the decade to come – in setting our return forecasts.

Thoughtful asset class return forecasts are essential to the management of the All Asset portfolios. When applied to historical data, Research Affiliates’ building blocks approach has been notably accurate: Most of these 10-year forecasts since 1971 were within about 2 percentage points of the subsequent 10-year actual real returns. (For details, please see the November 2020 All Asset All Access.) So, if we see a 10 percentage point spread in current forecasts, we sit up and take notice! By objectively forecasting potential returns using a disciplined approach, we can focus our attention on comparative valuation levels that are at odds with market perceptions.

Our models guide us to average into what we deem to be cheaply valued asset classes at times when they are generally feared and shunned, helping us make the uncomfortable trades required when seeking to profit from contrarian investing over time. Through these same models, we also gradually shift away from what we deem to be richly valued asset classes with fading return prospects in environments of complacency. In short, our approach at Research Affiliates helps ensure a reliable contrarian rebalancing discipline is inherent within the All Asset strategies.

Q: Before we delve into opportunities, what role do the All Asset strategies tend to serve in investor portfolios?

Arnott: All Asset is a focused “Third Pillar” strategy (our term for a diversifying approach incorporating real return assets, high yield bonds, and emerging markets (EM)), while All Asset All Authority is even more powerfully divergent, hence more diversifying. We do not advocate that investors use the All Asset strategies instead of mainstream stocks and bonds; instead our strategies serve as a diversifying complement to an investor’s existing allocations to mainstream stocks and bonds.

Our friend and former colleague, Jason Hsu, likes to describe diversification as “regret maximizing.” Because diversification can feel so uncomfortable in a bull market, many investors anchored on a mainstream 60/40 stock/bond mix regret their diversifiers; some even slash their diversifying assets to chase the kinds of assets that we now believe are in bubble territory. As a result, many investors today may lack sufficient diversification away from U.S.-centric equity risk – and in our view, this means they face low prospective returns on their conventional holdings and are vulnerable to renewed inflation.

These issues are arguably more urgent today than any time since the launch of the All Asset strategies in 2002. Just as the 2000s saw a stark reversal of the go-go 1990s (which ended in a tech-led equity bubble), we believe the 2020s could similarly deliver a stark reversal on current speculative growth holdings (many of which appear to be in bubble territory once again).

Q: Where does Research Affiliates see opportunities for attractive potential multi-year returns?

Arnott: As we scan capital markets today, we find that among the roster of diversifying markets, developed market ex U.S. equities (proxied by the MSCI EAFE (Europe, Australasia, and the Far East) Index) are trading at prices that generate a high relative yield, which in turn positions them for a long-term forward-looking estimated nominal return of 6% (4% real), according to our model. We estimate emerging market equities (proxy: MSCI EM Index) are priced to deliver about 2 percentage points more than this, albeit at higher risk.

Within the All Asset suite, we typically access these markets using the PIMCO RAE strategies, which generally have a stark value tilt. Our smart beta research forecasts value stocks to beat the broader stock market by roughly 4 to 5 percentage points per annum over the coming five years, suggesting the potential for even more attractive returns in international and EM equities (value stocks are proxied by companies selected from the broader equity universe on the basis of a value score, which Research Affiliates calculates from price, earnings, and other data and weights by market capitalization; the broader stock market is proxied by the top 500 stocks by market cap (U.S.) and all stocks in the large and mid cap starting universe (developed and emerging markets), weighted by market capitalization).

Unsurprisingly, the All Asset strategies have increased their allocations to international stocks over the last year (albeit some coming from EM stocks, where the momentum is – for now – less encouraging). As of 31 December 2020, the allocation to developed ex U.S. equity strategies is 14.4% in the All Asset strategy and 14.3% in the All Asset All Authority strategy.

Another Third Pillar market we have opportunistically shifted into is real estate investment trusts REITs, which in our estimates are poised to deliver a long-term nominal return of 4% over the coming decade (proxy: FTSE NAREIT All Equity REIT Index). As of 30 December 2020, REITs and commodities combined represented a 15.0% allocation in the All Asset Fund and a 13.4% allocation in the All Asset All Authority Fund.

Relative to diversifying markets, our long-term nominal return forecasts for mainstream U.S. stocks and bonds are paltry, ranging from −1% per annum for U.S. long Treasuries (proxy: Bloomberg Barclays U.S. Treasury Long Index) to 2% for U.S. large stocks (proxy: S&P 500). Research Affiliates’ model finds the conventional 60/40 portfolio (with 60% equities proxied by the S&P 500 and 40% bonds proxied by the Bloomberg Barclays U.S. Aggregate Bond Index) is priced to deliver a return of 1.8% in nominal terms, and a shocking shortfall of −0.4% per annum(!) net of inflation, Footnote[i]over the coming decade.

As we’ve noted, value-oriented stocks remain extraordinarily compelling. The pandemic year of 2020 was the single worst year for value strategies in my career. We have to go back to 1931 to find a year remotely this bad for value. We all understand the reasons for the shortfall: Tech/growth stocks seem to have been ideally positioned to thrive amid COVID-19 (and the lasting changes we’ll see in a post-pandemic world), while value stocks demonstrated anemic growth (or worse) and skinny profit margins in 2020, exposing them to greater bankruptcy risk. But how much of this narrative is not already reflected in prices? Across many regions, relative to their growth counterparts, value stocks are trading close to the cheapest levels they ever have over the past four decades where data is available. We believe this is a remarkable opportunity for value investors, as my colleague Jim Masturzo will discuss in more detail.

Q: Before we turn to value-oriented asset classes, does Research Affiliates believe all equity markets are frothy?

Masturzo: Several metrics indicate U.S. stock markets have been trading at rich valuations (relative to historical averages) for some time now. For example, we note the ratio of the total market capitalization of U.S. equities (proxied by the Wilshire 5000) compared with U.S. gross domestic product (GDP) has now risen to 160% as of Q4 2020. Not only are U.S. stocks valued at 60% more than U.S. GDP, but the current value is roughly double the average since 1975 of just under 80% (sources: Bloomberg and the U.S. Bureau of Economic Analysis or BEA).

Focusing on just large cap equities, the S&P 500 is also trading rich with a cyclically adjusted price/earnings (CAPE) multiple of 33.5 and a long-term median value of 16.

We note the froth does not appear to extend to global equity markets. For example, developed markets outside the U.S. are trading at a CAPE multiple of close to 18, while emerging markets trade close to 16.5.

Q: Why would investors consider allocations to value-oriented asset classes when most mainstream equity markets appear to be approaching all-time highs?

Masturzo: Although the All Asset strategies do at times invest in pure capitalization-weighted equity indices, the opportunity set includes a range of attractive value-oriented strategies as well. Similar to their cap-weighted counterparts, both developed market and emerging market value indices are trading at CAPE ratios well below their long-term averages: As of December 2020, developed markets (proxied by MSCI EAFE Value Index) were trading at a CAPE of 12 against an average of 19, while the comparison is 10 versus 14 for EM (proxied by MSCI EM Value Index). Even in the U.S, the Russell 1000 Value Index CAPE appears fairly priced at its long-term average.

When compared with growth counterparts, value-based indices have tended to cheapen over much of the last decade, and even more so in the last year or two. Figure 1 shows the ratio from dividing the CAPE of a cap-weighted value index by the CAPE of the corresponding growth index. In each region, value has gotten cheaper relative to growth, an illustration of the generally poor relative performance of value stocks in the 2010s.

Figure 1: The ratio of value CAPE to growth CAPE (1978–2020) indicates growth has outpaced value for much of the past decade

Figure 1 is a line chart depicting the ratio of the cyclically adjusted price-to-earnings ratio (CAPE) of value stocks to the CAPE of growth stocks over the time frame 1978–2020 in three regions: the U.S., developed markets outside the U.S. (Europe, Australasia, Far East or EAFE), and emerging markets. In EAFE and EM, the ratio has declined from roughly 0.8 in 2008 to 0.4 in 2020, and in the U.S. the ratio has declined from just under 0.8 in 2016 to just above 0.4 in 2020. Overall, the chart shows how growth stocks have generally outpaced value stocks in recent years, according to this measure. Source and proxies are listed below the chart.

The good news is that the cheaper prices of value-based strategies mean this may be an attractive time to invest in these assets. Our research finds that at current valuation levels, value-based strategies historically have tended to perform well over subsequent five-year periods, with annualized excess returns on the order of 5%–15%. And remember that in the All Asset portfolios specifically, much of the equity exposure is obtained through the PIMCO RAE PLUS suite, which combines return from the equity exposure with incremental return potential from the actively managed collateral and any associated alpha.

Q: Finally, how is Research Affiliates positioning the All Asset strategies in this environment?

Masturzo: The All Asset portfolios are currently near all-time high exposure levels in value-based equity strategies. We note that neither developed ex U.S. (EAFE) stocks nor emerging market equities are expensive, and value strategies have continued to cheapen.

An additional tailwind we see for investing in value stocks is that compared with cap-weighted value indices, PIMCO RAE strategies – which are the bulk of All Asset equity exposure – historically tend to trade at multiples cheaper than their cap-weighted counterparts in both the U.S. and emerging markets, and close to parity in developed ex U.S. international markets.

RAE strategies also have the systematic ability to ratchet up value exposure when value is more attractive, as it appears today. The All Asset strategies are positioned to take advantage of the potential opportunities afforded by buying these assets at a discount, while trimming exposure to some other asset classes, fixed income in particular, that currently appear to trade at significantly negative yields adjusted for inflation.

Institutional investors and financial professionals: Register here for the All Asset webcast on 11 March 2021 to learn more about the All Asset strategy and outlook.

The All Asset strategies represent a joint effort between PIMCO and Research Affiliates. PIMCO provides the broad range of underlying strategies – spanning global stocks, global bonds, commodities, real estate, and liquid alternative strategies – each actively managed to maximize potential alpha. Research Affiliates, an investment advisory firm founded in 2002 by Rob Arnott and a global leader in asset allocation, serves as the sub-advisor responsible for the asset allocation decisions. Research Affiliates uses their deep research focus to develop a series of value-oriented, contrarian models that determine the appropriate mix of underlying PIMCO strategies in seeking All Asset’s return and risk goals.

[i] The forecast for inflation is adapted from market forecasts for inflation. For countries and regions with active inflation swap markets (Australia, European Union, Japan, South Africa, U.K., and U.S.), the current inflation swap term structure is used to forecast inflation.

The Author

Robert Arnott

Founder and Chairman, Research Affiliates

Jim Masturzo

Head of Asset Allocation, Research Affiliates


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Investors should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. This and other information are contained in the fund’s prospectus and summary prospectus, if available, which may be obtained by contacting your investment professional or PIMCO representative or by visiting Please read them carefully before you invest or send money.


Please note that the following contains the opinions of the manager as of the date noted and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.

Past performance is not a guarantee or a reliable indicator of future results.

A word about risk:

The All Asset and All Asset All Authority strategies invest in other PIMCO funds and performance is subject to underlying investment weightings which will vary. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors.  Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies.  Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested.  The cost of investing in the Fund will generally be higher than the cost of investing in a fund that invests directly in individual stocks and bonds. The Fund is non-diversified, which means that it may invest its assets in a smaller number of issuers than a diversified fund.

Return assumptions are for illustrative purposes only and are not a prediction or a projection of return. Return assumption is an estimate of what investments may earn on average over the long term. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods.

Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve. Research Affiliates return forecasts may vary from PIMCO’s capital market assumptions.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.

The cyclically adjusted price-to-earnings ratio (CAPE) is a valuation measure defined as price divided by the average of ten years of earnings, adjusted for inflation.

S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The Index focuses on the large-cap segment of the U.S. equities market. Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000® Value Index measures the performance of large and midcapitalization value sectors of the U.S. equity market, as defined by FTSE Russell. The Russell 1000® Value Index is a subset of the Russell 1000® Index, which measures the performance of the large and mid-capitalization sector of the U.S. equity market. MSCI EAFE Index is an unmanaged index designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The MSCI EAFE Growth Index captures large and mid cap securities exhibiting overall growth style characteristics across Developed Markets countries* around the world, excluding the US and Canada. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. The MSCI EAFE Value Index captures large and mid-cap securities exhibiting overall value style characteristics across developed markets countries around the world, excluding the US and Canada. The value investment style characteristics for index construction of the MSCI EAFE Value Index are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The Barclays 1-3 Year U.S. Treasury Index is a market capitalization-weighted index including all U.S. Treasury notes and bonds with maturities greater than or equal to one year and less than three years. The MSCI Emerging Markets Growth Index captures large and mid cap securities exhibiting overall growth style characteristics across 27 Emerging Markets (EM) countries*. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. The MSCI Emerging Markets Value Index captures large and mid-cap securities exhibiting overall value style characteristics across 24 emerging markets countries. The value investment style characteristics for index construction of the MSCI Emerging Markets Value Index are defined using three variables: book value to price, 12-month forward earnings to price and dividend yield. Bloomberg Barclays Long-Term Treasury Index consists of U.S. Treasury issues with maturities of 10 or more years. The Bloomberg Barclays High Yield Index is an unmanaged market-weighted index including only SEC registered and 144(a) securities with fixed (non-variable) coupons.  All bonds must have an outstanding principal of $100 million or greater, a remaining maturity of at least one year, a rating of below investment grade and a U.S. Dollar denomination. Bloomberg Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. The National Association of Real Estate Investment Trusts (NAREIT) Equity Index is an unmanaged market weighted index of tax qualified REITs listed on the New York Stock Exchange, American Stock Exchange and the NASDAQ National Market System, including dividends. Bloomberg Commodity Index is an unmanaged index composed of futures contracts on a number of physical commodities. The index is designed to be a highly liquid and diversified benchmark for commodities as an asset class. The futures exposures of the benchmark are collateralized by US T-bills. The Wilshire 5000 Equity Index measures the performance of all U.S. headquartered equity securities with readily available price data. Over 7,000 capitalization weighted security returns are used to adjust the index. It is not possible to invest directly in an unmanaged index.

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