Unintended Risks in Capital Market Assumptions

Allspring proposes a risk-based 'GRAIL' framework for portfolio construction that derives return assumptions from risk budgets rather than using them as inputs. This approach aims to reduce the uncertainty and behavioral biases inherent in traditional building-block capital market assumptions.

Key Takeaways

• 1.Traditional building-block CMAs are flawed due to highly uncertain inputs like the equity risk premium (ERP) and a tendency for users to 'tweak' inputs to reach desired results.
• 2.A risk-based framework reverses the traditional process by assigning risk budgets first and treating return assumptions as the output rather than the input.
• 3.The GRAIL framework identifies growth, rates, and inflation as the primary macroeconomic drivers of return, noting that credit spreads are highly correlated with growth (equities).

Table of Contents

• Addressing the disconnect with a risk-based framework
• WHAT IS RISK BUDGETING?
• Correlations and responsiveness to macroeconomic drivers matter
• Applying our risk-based portfolio construction process
• Risk-based portfolios address the disconnect

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