{"id":27448,"date":"2023-06-10T11:43:02","date_gmt":"2023-06-10T11:43:02","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=27448"},"modified":"2024-03-15T10:59:39","modified_gmt":"2024-03-15T10:59:39","slug":"role-and-framework-of-capital-market-expectations-cmes","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-iii\/role-and-framework-of-capital-market-expectations-cmes\/","title":{"rendered":"Role and Framework of Capital Market Expectations (CMEs)"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/ehQwXu6z12M\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>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&#8217; primary driver.<\/p>\n<p><em><strong>Macro expectations<\/strong><\/em> involve forecasting risk and returns for an entire asset class. In contrast, <strong>micro expectations<\/strong> involve setting expectations for individual securities. Expectations should show <em><strong>cross-sectional consistency<\/strong><\/em>, meaning internal consistency within a specific asset class. In addition, expectations need to adhere to <em><strong>intertemporal consistency<\/strong><\/em>, which refers to the maintenance of similar traits across various investment horizons.<\/p>\n<p>In summary, Capital Market Expectations (CMEs) play the following roles:<\/p>\n<ul>\n<li>They are critical inputs in deciding strategic asset allocation.<\/li>\n<li>They allow portfolio managers to build efficient portfolios.<\/li>\n<li>They help formulate risk and return expectations for broad asset classes.<\/li>\n<li>They align the risk-return objectives with investor expectations.<\/li>\n<li>They can be used to identify short-term mispricing.<\/li>\n<\/ul>\n<h2>The 7-step Process<\/h2>\n<p>The CFA curriculum recommends investment professionals&#8217; adherence to a disciplined approach to setting capital market expectations. The approach involves the following 7-step framework:<\/p>\n<ol type=\"I\">\n<li><em><strong>Specify expectations needed<\/strong><\/em>: This initial step requires creating an explicit, written list of the asset classes and investment time horizons involved.<\/li>\n<li><em><strong>Examine historical records<\/strong><\/em>: While not the final projection, analysts must study and understand previous asset class characteristics and attempt to understand what drives them.<\/li>\n<li><em><strong>Specify methods and models<\/strong><\/em>: The most appropriate methods must be predetermined and used throughout the framework to ensure consistency.<\/li>\n<li><em><strong>Determine best sources of information<\/strong><\/em>: Established sources are the best. However, analysts are expected to stay abreast of emerging sources and fully understand the data used.<\/li>\n<li><em><strong>Interpret current environment<\/strong><\/em>: Analysts must deliver a common set of assumptions with consistent methodologies and judgments based on experience.<\/li>\n<li><em><strong>Deliver documented expectations<\/strong><\/em>: The expectations should be supported by reasoning and assumptions in a documented form.<\/li>\n<li><em><strong>Monitor actual outcomes<\/strong><\/em>: As the expectations turn into outcomes, they should be recorded, monitored, and studied. This can improve and hone future forecasts.<\/li>\n<\/ol>\n<blockquote>\n<h2>Question<\/h2>\n<p>Which of the following <em>most likely<\/em> serves as the primary driver of portfolio returns?<\/p>\n<ol type=\"A\">\n<li>Portfolio asset allocation.<\/li>\n<li>Tax efficiency and tax location.<\/li>\n<li>Returns in the form of dividends versus capital gains.<\/li>\n<\/ol>\n<h4>Solution<\/h4>\n<p><strong>The correct answer is A<\/strong>:<\/p>\n<p>Capital market expectations inform the process of choosing a portfolio asset allocation, which positively correlates to portfolio returns.<\/p>\n<p><strong>B is incorrect<\/strong>.\u00a0Taxes are considered a secondary consideration in portfolio management.<\/p>\n<p><strong>C is incorrect<\/strong>. Returns in dividends versus capital gains refer to investor preferences and do not change the portfolio&#8217;s return\u00a0 since dividends can be &#8216;homemade&#8217;.<\/p>\n<\/blockquote>\n<p>Reading 1: Capital Market Expectations &#8211; Part 1 (Framework and Macro Considerations)<\/p>\n<p><em>Los 1 (a) Discuss the role of, and a framework for, capital market expectations in the portfolio management process<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>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&#8217; primary driver. Macro expectations involve forecasting risk and returns for an entire&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[571],"tags":[],"class_list":["post-27448","post","type-post","status-publish","format-standard","hentry","category-cfa-level-iii","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Role and Framework of Capital Market Expectations (CMEs) - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"The 7-step process recommended by the CFA curriculum for setting capital market expectations, and how they drive portfolio returns.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-iii\/role-and-framework-of-capital-market-expectations-cmes\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Role and Framework of Capital Market Expectations (CMEs) - 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