Can returns on countries and asset classes be forecasted? In relative terms, we believe they can. Clover may not be able to predict with certainty if the US market will deliver a return of 10% next year, but we have the tools to determine if the US will outperform the UK. Two core reasons form the basis of our belief: market equilibrium and market inefficiency.
Market equilibrium
Individual investors in the market have different perceptions of risk. This leads to a risk-sharing equilibrium in which some investors buy the risks that others sell. When you think about it, for each investment you buy, there is somebody selling. Equilibrium models teach us about the relationship between risk and return.
Market inefficiency
Inefficiencies occur due to:
- Investors’ long-term overreaction and short-term underreaction to information.
- Market segregation or constraints such as regulatory restrictions on the free flow of capital across markets.
- Non-economically motivated players in capital markets, such as central banks and governments.
Clover Asset Management uses the following sources of information to establish its Global Tactical Asset Allocation:
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