Return Expectations and Portfolios: Evidence from Large Asset Managers

The largest asset managers in the world report their expectations publicly in so-called capital market assumptions. We collect these expectations and revisit the relationship between equity premium expectations and equity valuation ratios. Asset managers' equity premium expectations are high when valuations are low and low when valuations are high (countercyclical), and the term structure of equity premium expectations is downward sloping when valuations are low and upward sloping when valuations are high (procyclical). Studying mutual funds that invest in both equities and bonds, we find that the sensitivity of portfolios to expectations is large on average and even larger for funds that are less constrained by their investment mandates. Overall, the results support rational expectations asset pricing models.