This scatter plot shows the capital market line (performance vs. risk) based on Wells Fargo Investment Institute’s long term asset class capital market assumptions. Expected geometric returns are listed as follows: Investment grade fixed income: 3.9%, High yield fixed income: 6.7%, Developed market ex-U.S. fixed income: 2.7%, Emerging market fixed income: 6.5%, U.S. Large Cap Equities: 7.8%, U.S. Mid Cap Equities: 8.3%, U.S. Small Cap Equities: 8.0%, Developed market ex-U.S. equities: 6.9%, Emerging market equities: 8.0%, Commodities: 7.5%, Hedge Funds: 5.9%, Private Real Estate: 8.1%, Private Equity: 12.1%, Private Debt: 9.1%. Expected standard deviations are listed as follows: Investment grade fixed income: 3.8%, High yield fixed income: 9.5%, Developed market ex-U.S. fixed income: 8.0%, Emerging market fixed income: 10.0%, U.S. Large Cap Equities: 16.0%, U.S. Mid Cap Equities: 17.0%, U.S. Small Cap Equities: 20.0%, Developed market ex-U.S. equities: 17.0%, Emerging market equities: 21.0%, Commodities: 16.0%, Hedge Funds: 6.5%, Private Real Estate: 13.0%, Private Equity: 21.0%, Private Debt: 13.5%.
Risks
Capital market and asset class assumptions are estimates of how asset classes and combinations of classes may respond during various market environments. Expected returns represent our estimate of likely average returns over the next several market cycles. They do not represent the returns that an investor should expect in any particular year. Geometric return is the compounded annual return that would give the same result as a given series of annual returns based on those same assumptions. The return and risk assumptions are statistical averages that do not represent the experience of any individual investor or any specific time period. Standard deviation is a measure of volatility. It reflects the degree of variability surrounding the outcome of an investment decision; the higher the standard deviation, the greater the risk.
CMA forecasts are not promises of actual returns or performance that may be realized. They are based on estimates and assumptions that may not occur.
The information does not take into account the specific investment objectives, financial situation and particular needs of any specific person who may receive it. Investors should understand that statements regarding future prospects may not be realized.
Risk considerations
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stocks may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility.
Alternative investments, such as hedge funds, private equity/private debt funds and private real estate funds, are speculative and entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds.
Hedge fund, private equity, private debt and private real estate fund investing involves other material risks including capital loss and the loss of the entire amount invested. They are intended for qualified, financially sophisticated investors who can bear the risks associated with these investments. Hedge fund strategies, such as Equity Hedge, Event Driven, Macro and Relative Value may expose investors to risks such as short selling, leverage, counterparty, liquidity, volatility, the use of derivative instruments and other significant risks.
Source: Wells Fargo Investment Institute. Strategic (long-term) return assumptions are as of July 18, 2023. For illustrative purposes Forecasts are based on certain assumptions and on views of market and economic conditions which are subject to change. Strategic expected returns are forward-looking geometric return estimates from Wells Fargo Investment Institute of how asset classes and combinations of classes may respond during various market environments. Expected returns do not represent the returns that an investor should expect in any particular year. They are not designed to predict actual performance and may differ greatly from actual performance. There are no assurances that any estimates given will be achieved.
FI = fixed income. DM = developed markets. EM = emerging markets. Inv grade = investment grade.
Key Takeaways
- In general, similar asset classes have similar expected risk and return relationships. Asset classes in the same asset group, like fixed income or equity, tend to be grouped together on the forward-looking capital market line.
- The alternative investments asset group is somewhat of an exception to that tendency. Some alternative asset classes such as hedge funds exhibit more moderate risk and return expectations, compared to others like private equity which exhibit higher risk and return expectations.