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Capital market expectations involve setting likely risk and return parameters for a portfolio. These expectations inform the asset allocation that is ultimately selected, which is the investment results’ primary driver.
Macro expectations involve forecasting risk and returns for an entire asset class. In contrast, micro expectations involve setting expectations for individual securities. Expectations should show cross-sectional consistency, meaning internal consistency within a specific asset class. In addition, expectations need to adhere to intertemporal consistency, which refers to the maintenance of similar traits across various investment horizons.
In summary, Capital Market Expectations (CMEs) play the following roles:
The CFA curriculum recommends investment professionals’ adherence to a disciplined approach to setting capital market expectations. The approach involves the following 7-step framework:
Question
Which of the following most likely serves as the primary driver of portfolio returns?
- Portfolio asset allocation.
- Tax efficiency and tax location.
- Returns in the form of dividends versus capital gains.
Solution
The correct answer is A:
Capital market expectations inform the process of choosing a portfolio asset allocation, which positively correlates to portfolio returns.
B is incorrect. Taxes are considered a secondary consideration in portfolio management.
C is incorrect. Returns in dividends versus capital gains refer to investor preferences and do not change the portfolio’s return since dividends can be ‘homemade’.
Reading 1: Capital Market Expectations – Part 1 (Framework and Macro Considerations)
Los 1 (a) Discuss the role of, and a framework for, capital market expectations in the portfolio management process