Model update
When it comes to investment forecasting (and by proxy, asset allocations), everything depends on interest rates, especially fixed income returns. Modelling interest rates is of fundamental importance when modelling return and risk over the long term. When rates increase, future return expectations for cash and bond returns rise. Moreover, to estimate the risk of bonds over different investment horizons, it is essential to consider how the negative price impact of interest rate rises is offset by improved reinvestment returns over the time horizon of interest.
For these reasons, the EVAns asset model starts by modelling interest rates. Returns for cash and fixed income assets are directly determined by the evolution of interest rates. All other asset classes have some dependency on interest rates. We expect growth rates to be higher when interest rates are high, so equity dividend growth rates and property rent growth rates are linked to interest rates. Property rental yields are expected to depend on the cost of finance, so they are linked to interest rates. Interest rates also determine market expectations of future exchange rates, so currency strengths are linked to interest rates.