Estimating forward-looking asset class returns is an unavoidable necessity for investors constructing portfolios. What options do investors have for determining long-term return expectations? Differing asset definitions, data sets, and methodological details can result in a vast diversity of individual models and estimates, but most boil down to one of the following estimation archetypes:

 

  1. Estimating long-run return premia from historical data, as done in our paper, Forecasting Factor Returns.
  2. Building up forecasts from current valuations, combining estimates for sub-components of longer-term returns such as income and growth expectations.
  3. Harnessing the wisdom of crowds, by surveying or estimating the average forward-looking views of market participants.

 

In a recent Street View, our colleagues on the Two Sigma Client Solutions Research team (the group responsible for developing new Venn factors and methodologies) delve into a particular quantitative example of the third method: harnessing the wisdom of crowds. By applying a tool called reverse optimization to the worldwide investable asset portfolio, we show how long-term factor and asset class returns can be estimated from the aggregated allocation decisions of all investors.

 

Read Estimating Global Investor Views with Reverse Optimization

 

While this Street View applies the reverse optimization method to the global market portfolio in order to estimate aggregated global investor outlooks for different asset classes, another application of the technique is to apply it to your portfolio to back out implied views on factors or individual holdings. Comparing these implied views to other return estimation methods, such as long-term realized returns or investors’ capital market assumptions, could identify areas of misalignment between actual portfolio positioning and forward-looking return expectations.

 

The Venn team is looking at how we can bring this reverse optimization research into Venn. Get in touch with your Venn relationship manager to learn more. Not a Venn Pro user? Sign up for free to get access to features like reverse optimization today.

 

This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed.  The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment.  This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time.  Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. See the end of the document for other important disclaimers and disclosures. Click here for other important disclaimers and disclosures.

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