2021 capital market expectations continued support for

FRANKLIN TEMPLETON THINKSTM CAPITAL MARKET EXPECTATIONS

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Continued support for asset returns

2021 CAPITAL MARKET EXPECTATIONS

For Financial Professional Use Only. Not For Public Distribution.

Contents

About capital market expectations

Summary 3

Our capital market expectations 4

Our strongest convictions 6

Appendix

Historical correlations 10

Methodology and models 12

Indexes and proxies 14

Every year we review the data that drive capital markets—current valuation measures, historical risk premia, economic growth and inflation prospects—to provide the foundation for our forecasts. We update the models that we use and review their continued appropriateness. Where necessary, we phase in required changes. Crucially, our models are based on first-principle economic relationships and reflect seasoned practitioner judgment.

We continue to include as part of every capital market forecast a measure of the expected volatility of that asset class, informed by long-term observed standard deviation of returns. Given that global central banks’ quantitative easing policies may have repressed both equity and bond market volatility over recent years, our approach to modeling volatility avoids the recency bias of some alternative approaches and is particularly appropriate at a time when leading central banks have approached the limits of conventional interest rate policy.

Our capital market expectations (CME) are designed to provide annualized return expectations over a longer-term horizon, typically viewed as 10 years. Specifically, we calculate geometric mean return expectations over a 10-year period, which both fully captures the average length of a US business cycle and aligns with the strategic planning horizon of many institutional investors. This length of horizon is especially relevant as we enter the early part of a new economic expansion following the coronavirus- induced recession.

Our modeling approach is based on a blend of objective inputs, quantitative analysis, and fundamental research, consistent with the skill set of our recently combined Franklin Templeton Investment Solutions (FTIS) business. Underpinning these inputs are assumptions on the sustained growth rates that developed and emerging economies can expect to achieve and the level of price inflation they will likely experience. This approach is forward-looking, rather than being based on historical average returns. This is especially important in an evolving macroeconomic environment.

32021 capital market expectations: Continued support for asset returns


Summary

We believe global stocks have greater performance potential than global bonds, supported by sustained growth and moderate inflation. With short-term interest rates and government bond term premia remaining below historical averages, we see lower performance potential from government bonds, dragging down asset returns generally. Equity and corporate bond risk premia remain attractive and we continue to forecast stronger return potential for emerging markets over a 10-year investment horizon.

Our strongest convictions: • Portfolio return potential moving lower • Asset risk premia near average levels • Portfolio diversification remains key

2021 capital market expectations: Continued support for asset returns4


Our capital market expectations

Our 2021 capital market expectations are that the expected returns of global equities and corporate bonds will be more attractive than the expected returns of global government debt.

Our geometric mean return expectation over a 10-year period for global equities is broadly in line with the historical annualized return. Overall, we expect global equities to return 5.6% annualized over the 10-year period, with developed markets returning 5.4%.1

By comparison, we expect global developed government bonds to return only 0.3% in US dollar terms.2

Asset class name Expected Expected Past 20-yr return risk annlzed (geometric) (std. dev.) return

GLOBAL GOVERNMENTS

Global developed governments 0.3% 6.2% 4.2%

US government 0.8% 4.3% 4.6%

Canadian government 1.1% 8.3% 3.6%

Euro government 0.3% 9.6% 5.4%

UK government 0.7% 8.9% 4.5%

Japanese government –0.8% 9.9% 1.5%

Australian government 1.0% 10.1% 7.4%

Inflation linked

Global inflation linked 0.7% 7.0% 5.4%

US TIPS 1.0% 5.2% 5.6%

Euro inflation linked 1.5% 10.7% 4.8%

UK inflation linked –0.9% 10.6% 5.7%

GLOBAL CREDIT

Global investment grade credit 1.8% 5.7% 4.0%

US investment grade 2.0% 5.6% 5.2%

Euro investment grade 1.6% 10.2% 5.2%

UK investment grade 1.8% 11.4% 2.9%

Global high yield 4.9% 9.8% 7.9%

US high yield 4.8% 9.1% 7.1%

Euro high yield 4.6% 14.7% 7.1%

UK high yield 5.5% 13.9% 7.2%

US high yield loans 4.5% 6.6% 4.7%

US securitized

US MBS 1.1% 2.4% 4.8%

Municipal bonds

US munis 1.4% 4.1% 5.0%

Emerging markets goverments

Emerging market debt-gov (Hard)* 4.4% 8.8% 7.3%

Emerging market debt-gov (Local)* 3.8% 11.9% 5.3%

Emerging market debt (Corp)* 4.1% 9.6% 6.5%


GLOBAL EQUITY 5.6% 15.3% 4.5%

Developed-market equity 5.4% 15.1% 4.5%

US 5.4% 15.1% 5.9%

Canada 5.5% 19.4% 6.1%

EAFE 5.3% 15.8% 3.3%

EMU 5.8% 19.9% 3.6%

UK 6.1% 16.2% 3.2%

Japan 4.8% 14.9% 1.3%

Pacific ex Japan 5.8% 19.1% 7.1%

Australia 5.9% 21.0% 8.2%

Emerging market equity 7.0% 20.4% 6.7%

China 7.1% 23.8% 7.5%

Specialty equity

Global listed infrastructure* 5.6% 15.5% 8.0%

US listed infrastructure** 5.0% 11.8% 8.9%

Global REITs 5.7% 17.7% 10.7%

US REITs 5.6% 20.0% 11.3%

10-YEAR ANNUALIZED CAPITAL MARKET EXPECTATIONS (USD) RETURN EXPECTATIONS Equity expectations As of September 30, 2020

Fixed income expectations As of September 30, 2020

Source: Franklin Templeton Investment Solutions.


1. There is no assurance any forecast, projection or estimate will be realized. 2. Ibid.

* Denotes where 15-year average is used (20-yr unavailable)** Denotes where 8-year average is used (20-yr unavailable)



CME Spot as of 9/30/2020

EXCHANGE RATES

USD CAD 1.28 1.33

EUR USD 1.21 1.17

GBP USD 1.32 1.29

USD JPY 111.65 105.53

AUD USD 0.71 0.71

CME Spot as of 9/30/2020

CASH short-term (3-month) cash rate

US cash 0.5% 0.13

CAD cash 0.4% 0.25

EUR cash –0.7% –0.5

GPB cash 0.0% 0.1

JPY cash –0.1% –0.1

AUD cash 0.5% 0.25


COMMODITIES

Commodities 3.2% 15.0% 1.0%

Oil 3.3% 38.4% 0.0%

Industrial metals 3.2% 20.3% 3.4%

Precious metals 2.6% 18.1% 7.5%

Agriculture 4.6% 17.8% –1.2%

ALTERNATIVES

Global hedge funds 4.2% 8.0% 5.2%

US private equity 7.0% 19.5% 10.5%

US private real estate 5.6% 15.6% 8.7%

Other expectations As of September 30, 2020


With fiscal policy playing a bigger role than traditional monetary easing, our debate about the sustainability of the resultant government debt was informa-tive for our longer-term outlook. The level of debt is not seen as an imme-diate concern, due to yield curve control leading to low and affordable debt- service costs. In the longer-term, the impact of deleveraging will continue to be felt globally, exacerbated by adverse demographics, perhaps constraining growth. China’s deleveraging will likely lead these dynamics moving forward.

As we look out over the next 10 years, the great power struggle between the United States and China also remains a key concern. We anticipate that this issue will not fade away. But equally, we see more nuanced outcomes depending on the issues and their geopolitical significance. In areas of national secu-rity and associated technology

leadership, a sharp divide may feel like a path toward escalation and tension. However, perhaps on environmental issues and certainly in less strategically significant areas of commerce, we expect to see greater engagement. The profit motive remains strong here and likely leads to accommodation rather than conflict.

Some of the behavioral changes associated with accelerated digital transformation have been very sharp. The pandemic brought forward years of progress towards acceptance of these changes into a period of a few weeks. We do not anticipate a broad return to the old way of working, though the expectations for the benefits of such technology are possibly outsized. All the same, we anticipate a boost to productivity that may support a stronger rebound as the recovery progresses. This, together with a

Themes driving long-term global growthIn creating these capital market expec-tations, we incorporate the Franklin Templeton Investment Solutions (FTIS) team’s views on longer-term investment themes that impact the global economy. We debate these themes at our Annual Investment Symposium, in collaboration with senior leaders from across Franklin Templeton’s wide range of asset class specialists.

At our recent symposium in October 2020, we again focused on debt accu-mulation. This seems to be a perennial theme but one that has taken on even greater relevance as global policymakers attempt to offset the effect of the coro-navirus recession. Indeed, as official interest rates have been cut toward their lower bound, policy coordination has become more ever-more important.

Our strongest conviction views



somewhat depressed starting point, compared with last year, see us upgrade our gross domestic product (GDP) growth expectations over the 10-year horizon used in our capital market expectations.

We expect sustained global growth and moderate inflation over the long term. With ongoing coordinated stimulus measures, the global economy is less likely to see extreme swings in output. We anticipate no more than a gradual, measured, interest rate tightening cycle in an environment where central banks are targeting average inflation over the next seven years.

As a result, we expect global GDP to expand at a 3.1% annual rate, with developed markets growing slightly more slowly. Inflation across the key devel-oped and emerging economies is expected to remain subdued, at 2.8% (See Exhibit 1).

These longer-term expectations are point forecasts that attempt to capture a broader range of different outcomes. We can encapsulate them in the four-quadrant matrix (See Exhibit 2). We retain a bias toward the lower-than- anticipated inflation sections, located in the bottom half of the table, but do not place a high level of confidence in any one particular outcome. At the same time, we retain a strong view that inflation will be driven by the level of demand, rather than supply constraints, leading us to favor outcomes on the minor diagonal (bottom left to top right).

Portfolio return potential moving lower The economic environment that we describe above remains supportive of asset returns generally. However, the subdued level of current inflation and strong desire by global central banks to support economic recovery through

8%

7%

6%

5%

4%

3%

2%

1%

MODERATE INFLATION COUPLED WITH STEADY GLOBAL GROWTHExhibit 1: Table of economic assumptions for 10 years As of September 30, 2020

Source: Franklin Templeton Investment Solutions. There is no assurance that any estimate, forecast or projection will be realized.

Global UnitedStates

Canada Germany UnitedKingdom

Japan Australia Brazil China India Russia

Real GDP In�ation

the provision of plentiful liquidity has pushed government bond yields to exceptionally low levels. With policy rates only expected to rise gradually, overall return expectations from all assets are lower than has been the case in past years.

The term premium is a measure of the extra yield that owners of bonds demand, in excess of the anticipated average level of short-term interest rates for the life of the bond, to compensate for making a longer-term investment (See Exhibit 3 on the next page). This premium reflects

GLOBAL GROWTH AND INFLATION SCENARIOSExhibit 2: Scenario descriptions

Stagnation• High debt service ratios limit the appetite and

productive use of credit.

• Aging demographics in key regions lead aggregate demand lower.

• Policy remains supportive but reactive, rather than proactive. Size of policy response is cautious.

Goldilocks• Proactive monetary and fiscal policy.

• Growing aggregate demand is met with increased investment, particularly in new technology; productivity increases.

• Globalization remains intact—excess supply keeps manufacturing prices low.

Stagflation• Supply restricted via ongoing US/China power

struggle; two regional trading blocs emerge.

• Supply restricted via rising nationalist ideologies, which aim to “bring jobs back home,” focus on increasing real wages.

• Inflation expectations become unanchored, as monetary policymakers view higher inflation as favorable.

Reflation• Fiscal policy remains proactive and sizable, led by

growing populism.

• Globalization evolves as multinationals looks to diversify their supply chains. This leads to some small price pressures.

• Monetary policymakers successfully manage inflation expectations higher by coordinating with fiscal policy (i.e. yield curve control or open-ended quantitative easing.)




4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0

-0.5

US TREASURY BOND TERM PREMIA DEPRESSED IN RELATION TO HISTORICAL AVERAGEExhibit 3: Term premium on 10-year zero coupon bond As of September 30, 2020

Source: Calculations by Franklin Templeton Investment Solutions using data sourced from Bloomberg, Adrian Crump & Moench 10-Year Treasury Term Premium (ACMTP10 Index). For illustrative purposes only. Past performance is not an indicator or guarantee of future results.

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Sep-20

supply and demand factors, including central banks’ quantitative easing policies, which have been re-started or extended in many markets in recent months. Demographics, and the invest-ment behavior of an aging population, continue to weigh on the term premium, as does the re-regulation of financial

institutions, which has boosted demand for safe assets (Basel II). This may result in bond yields remaining lower than our historical experience, even at the end of this cycle.

The depressed starting yield levels have their greatest impact on government

bonds. Global bonds—especially high credit quality and long-duration issues—appear vulnerable due to low current yields. In the longer term, any desire by developed market central banks to unwind unconventional policies and normalize interest rates would depress returns still further, for a while. Ultimately, higher real yields would support the return potential of bonds, following a period of adjustment likely to stretch beyond our 10-year horizon for capital market expectations.

We view the prospective return from low-risk assets as being primarily driven by the starting level for government bond yields, which are themselves driven by anticipated policy rates. This yield base provides the first building block of portfolio return potential. On top of this we layer additional elements for asset class risk premia (which we discuss in the next section) and risk premia for illiquidity or complexity. However, total prospective returns from broadly diversified portfolios will be dragged down by the base yield, in our opinion.

Asset risk premia near average levelsEquity markets have appreciated sharply in recent years and developed market valuations, based on price-to-earnings (P/E) ratios, are not cheap relative to their historical averages. However, in an environment of moderate inflation and subdued real interest rates, we believe that equities can continue to trade at significantly higher multiples than was the case in the 1970s and 80s. When we analyze equities relative to lower-risk assets, we believe global stocks have greater return potential than global bonds in an environment of continued global expansion and stimula-tive fiscal policy, thereby earning their equity risk premium (See Exhibit 4).

8

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5

4

3

2

1

Equity risk premium (%)

GLOBAL EQUITY VALUATIONS ARE NOT CHEAP, BUT ARE ATTRACTIVE, IN OUR OPINION, RELATIVE TO BONDS IN THE LONGER TERM Exhibit 4: Global equity risk premium As of September 30, 2020

Sources: Franklin Templeton Investment Solutions, Macrobond. Important data provider notices and terms at www.franklintempletonresources.com.

1990 1992 19961994 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 Sep-20

Global equity risk premium NBER recession



Similarly, the additional yield or spread that corporate bonds provide has come under pressure. A desire to enhance portfolio return potential has seen many investors add to holdings of higher- yielding securities, boosting demand for riskier fixed income assets. As a result, the current yield offered by corporate credit, especially lower-rated issues, is low by historical comparisons. However, when compared with lower-risk government bonds, whose yield we have noted is also historically depressed, the additional spread appears more normal. In addition, given our outlook for continued growth and a supportive policy backdrop, the risk premium contained within corporate bond yields seems at least adequate compensation for the likely level of risk of defaults. In addition to comparing yields, when we examine the correlation characteris-tics against equities of government bonds and credit, we observe higher

common factor exposure as one goes further out on the spread spectrum (See Exhibit 5).

More broadly, we believe that the avail-able alternative investments are all impacted by both the low base yield in financial markets and a natural reach for yield wherever it is available. As a result, the return potential for the various risk premia we have analyzed, while not cheap, are within normal ranges. Over the 10-year horizon used for our capital market expectations, we see relative stability in these risk premia and a constructive environment for asset returns.

Portfolio diversification remains keyWhen we look across the range of asset classes, the return potential of tradi-tional diversifying investments is notably lower than in past years. This has led many commentators to argue that the role lower-risk government bonds can play in a balanced portfolio could be reduced. The arguments for this course of action often also include observations that proximity to a lower bound for yields might diminish any diversification benefits.

We believe that maintaining a diversified portfolio of risk premia in addition to the traditional benefits of a balanced portfolio between stocks and bonds is the most likely path towards stable potential returns.”

HIGHER SPREAD FIXED INCOME HAS GREATER CORRELATION WITH EQUITIESExhibit 5: Fixed Income Asset Class Correlations to US Equities (unhedged USD) Estimated using 20-year historical data through September 30, 2020

Sources: Franklin Templeton Investment Solutions, Macrobond. Important data provider notices and terms available at www.franklintempletondatasources.com.

Correlation to US equities-40%-60%-80%-100% -20% 0 20% 40% 60% 80% 100%

US Government

US MBS

US TIPS

US Investment Grade

EMD—Hard

EMD—Local

US Loans

US High Yield



The current level of nominal yields provides only a limited cushion for even modest interest rate increases. Indeed, over the next 10 years, the return potential from developed market govern-ment bonds is likely to be less favorable than for stocks. However, the prospect of continued subdued inflation could potentially keep yields lower than we have seen over the last 30 years and has not significantly reduced the potential diversification benefits from these assets (See Exhibit 5).

More broadly, we also believe that active management of this asset mix can enhance potential return and manage the level of total portfolio risk that is taken.

We continue to see attractive prospects across emerging market asset classes. Emerging market currencies do not

appear to be overvalued against most developed market currencies at our starting point. Indeed, over the longer term, we would expect that the Balassa-Samuelson effect, which links increasing productivity with an appreciating real exchange rate, should result in a broad appreciation in emerging market currencies. This trend supports the return potential of unhedged positions to both bonds and stocks in emerging markets.

Emerging market bond yields are closer to historical averages than are depressed developed market real yields. Similarly, valuations for emerging market equities are still attractive across a range of measures. In both stocks and bonds, we believe the performance potential in emerging markets will exceed that of developed markets.

EXPECTED RETURNS OF EMERGING MARKETS AND DEVELOPED MARKETS (EQUITY AND BOND)Exhibit 6: Projected annualized returns (10-years forward) As of September 30, 2020

8%

7%

6%

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3%

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1%

Source: Franklin Templeton Investment Solutions. There is no assurance that any estimate, forecast or projection will be realized.

Equity Government bond

Emerging market Developed market

Expected return



Asset Classes

Asset Classes 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

1 Global Equity 1.0

2 Developed Market Equity 1.0 1.0

3 US Large Cap 1.0 1.0 1.0

4 Canada 0.9 0.9 0.8 1.0

5 EAFE 1.0 1.0 0.9 0.8 1.0

6 EMU 0.9 0.9 0.8 0.8 1.0 1.0

7 UK 0.9 0.9 0.8 0.8 0.9 0.9 1.0

8 Pacific ex Japan 0.9 0.9 0.8 0.8 0.9 0.8 0.8 1.0

9 Japan 0.8 0.8 0.7 0.6 0.8 0.7 0.7 0.7 1.0

10 Australia 0.9 0.9 0.8 0.8 0.9 0.8 0.8 1.0 0.6 1.0

11 Emerging Market Equity 0.9 0.8 0.8 0.8 0.9 0.8 0.8 0.9 0.7 0.8 1.0

12 China 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.8 0.6 0.7 0.8 1.0

13 Global Developed Gov Bond 0.1 0.1 0.0 0.2 0.2 0.2 0.1 0.2 0.1 0.2 0.2 0.2 1.0

14 US Government -0.4 -0.4 -0.4 -0.3 -0.4 -0.3 -0.4 -0.3 -0.3 -0.3 -0.3 -0.2 0.6 1.0

15 Euro Government 0.4 0.3 0.2 0.3 0.4 0.5 0.4 0.4 0.2 0.4 0.4 0.3 0.9 0.3 1.0

16 UK Government 0.3 0.3 0.2 0.3 0.3 0.3 0.4 0.3 0.2 0.3 0.3 0.3 0.6 0.3 0.6 1.0

17 Japan Government -0.1 -0.1 -0.2 0.0 -0.1 -0.1 -0.1 0.0 0.0 0.0 0.0 -0.1 0.7 0.5 0.4 0.2 1.0

18 Australia Government 0.7 0.6 0.6 0.7 0.6 0.5 0.6 0.8 0.4 0.7 0.8 0.6 0.6 0.0 0.6 0.4 0.4 1.0

19 Canada Government 0.6 0.5 0.5 0.7 0.5 0.5 0.5 0.6 0.4 0.6 0.6 0.5 0.6 0.2 0.6 0.5 0.3 0.8 1.0

20 Global Investment Grade 0.6 0.5 0.5 0.6 0.6 0.6 0.5 0.6 0.4 0.6 0.6 0.4 0.7 0.3 0.8 0.6 0.4 0.7 0.7 1.0

21 Investment Grade USD 0.4 0.4 0.3 0.5 0.4 0.4 0.4 0.5 0.3 0.5 0.4 0.3 0.6 0.4 0.5 0.5 0.3 0.5 0.6 0.9 1.0

22 Investment Grade EUR 0.6 0.5 0.4 0.5 0.6 0.6 0.6 0.6 0.4 0.6 0.6 0.5 0.8 0.1 0.9 0.6 0.3 0.7 0.6 0.9 0.6 1.0

23 Investment Grade GBP 0.6 0.6 0.5 0.6 0.6 0.6 0.7 0.6 0.4 0.6 0.5 0.5 0.5 0.0 0.6 0.9 0.1 0.5 0.5 0.8 0.6 0.7 1.0

24 Global High Yield 0.8 0.8 0.7 0.8 0.8 0.8 0.8 0.8 0.6 0.8 0.8 0.6 0.3 -0.2 0.4 0.3 0.0 0.6 0.6 0.7 0.7 0.6 0.6

25 High Yield USD 0.8 0.8 0.7 0.8 0.7 0.7 0.7 0.7 0.6 0.7 0.7 0.5 0.2 -0.2 0.3 0.3 0.0 0.6 0.5 0.7 0.6 0.5 0.6

26 High Yield EUR 0.8 0.7 0.6 0.7 0.8 0.8 0.8 0.8 0.5 0.7 0.8 0.6 0.5 -0.2 0.7 0.5 0.1 0.7 0.6 0.8 0.6 0.8 0.8

27 High Yield GBP 0.7 0.7 0.6 0.7 0.7 0.7 0.7 0.7 0.5 0.6 0.6 0.5 0.2 -0.3 0.4 0.6 -0.1 0.5 0.5 0.6 0.4 0.6 0.9

28 US High Yield Loans 0.6 0.6 0.6 0.7 0.6 0.6 0.6 0.6 0.5 0.6 0.6 0.4 0.0 -0.4 0.1 0.2 -0.1 0.4 0.3 0.5 0.5 0.4 0.5

29 US MBS -0.2 -0.2 -0.2 -0.1 -0.2 -0.2 -0.2 -0.1 -0.2 -0.1 -0.1 -0.1 0.6 0.8 0.3 0.3 0.4 0.2 0.3 0.4 0.5 0.2 0.1

30 US Munis 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.0 0.1 0.1 0.0 0.4 0.5 0.3 0.2 0.3 0.3 0.3 0.5 0.7 0.3 0.3

31 Global TIPS 0.4 0.4 0.3 0.5 0.5 0.5 0.4 0.5 0.3 0.5 0.5 0.4 0.8 0.4 0.8 0.8 0.4 0.7 0.7 0.9 0.7 0.8 0.7

32 EMD—Hard 0.6 0.6 0.5 0.6 0.6 0.6 0.6 0.6 0.4 0.6 0.6 0.4 0.4 0.1 0.5 0.4 0.2 0.6 0.7 0.8 0.8 0.6 0.5

33 EMD—Local 0.6 0.6 0.5 0.6 0.7 0.6 0.6 0.7 0.5 0.7 0.7 0.5 0.5 0.0 0.6 0.4 0.2 0.8 0.7 0.7 0.6 0.7 0.6

34 EMD—Corporate 0.6 0.6 0.5 0.6 0.6 0.6 0.6 0.7 0.4 0.6 0.6 0.5 0.3 0.0 0.4 0.3 0.1 0.6 0.6 0.8 0.7 0.6 0.6

35 Commodities 0.5 0.5 0.5 0.7 0.6 0.5 0.6 0.6 0.4 0.6 0.6 0.5 0.2 -0.2 0.4 0.3 0.1 0.6 0.5 0.5 0.3 0.5 0.4

36 Oil 0.4 0.4 0.4 0.5 0.5 0.4 0.5 0.4 0.4 0.4 0.4 0.3 0.0 -0.3 0.2 0.2 -0.1 0.2 0.3 0.3 0.2 0.3 0.3

37 Industrial Metals 0.5 0.5 0.5 0.6 0.5 0.5 0.5 0.6 0.4 0.6 0.6 0.5 0.2 -0.2 0.3 0.2 0.0 0.6 0.4 0.4 0.2 0.4 0.3

38 Precious Metals 0.2 0.2 0.1 0.4 0.2 0.2 0.2 0.3 0.2 0.3 0.4 0.3 0.6 0.3 0.5 0.4 0.5 0.5 0.5 0.5 0.4 0.5 0.3

39 Agriculture 0.3 0.2 0.2 0.3 0.3 0.2 0.3 0.3 0.2 0.3 0.3 0.2 0.2 -0.1 0.2 0.1 0.1 0.4 0.3 0.2 0.1 0.3 0.2

40 Global Listed Infrastructure 0.8 0.8 0.7 0.8 0.8 0.8 0.8 0.8 0.6 0.8 0.8 0.6 0.4 -0.1 0.5 0.4 0.1 0.6 0.6 0.7 0.6 0.7 0.6

41 Global REITs 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.7 0.5 0.8 0.7 0.5 0.3 -0.1 0.4 0.4 0.1 0.7 0.6 0.7 0.6 0.6 0.6

42 Global Hedge Funds 0.9 0.9 0.9 0.9 0.9 0.8 0.8 0.9 0.7 0.8 0.9 0.7 0.1 -0.4 0.3 0.3 -0.1 0.6 0.5 0.6 0.5 0.5 0.6

43 US Private Real Estate 0.1 0.1 0.1 0.1 0.2 0.1 0.2 0.2 0.1 0.1 0.1 0.1 -0.1 -0.1 0.0 0.1 -0.1 0.0 0.0 0.0 0.0 0.0 0.1

44 US Private Equity 0.4 0.4 0.4 0.3 0.4 0.3 0.4 0.3 0.3 0.3 0.3 0.2 -0.1 -0.2 0.0 0.1 -0.1 0.1 0.1 0.1 0.0 0.1 0.2

Appendix

Histrorical correlation

Long term correlations between major asset classes, estimated using 20-year historical data. Expected correlations help quantify the relationships among asset classes. Expected correlation is as important as expected return and risk estimates when constructing portfolios.



Asset Classes 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44

24 Global High Yield 1.0

25 High Yield USD 1.0 1.0

26 High Yield EUR 0.9 0.8 1.0

27 High Yield GBP 0.8 0.7 0.9 1.0

28 US High Yield Loans 0.8 0.8 0.7 0.7 1.0

29 US MBS 0.0 0.0 0.0 -0.1 -0.2 1.0

30 US Munis 0.4 0.3 0.3 0.1 0.3 0.5 1.0

31 Global TIPS 0.6 0.5 0.7 0.5 0.4 0.4 0.5 1.0

32 EMD—Hard 0.8 0.7 0.7 0.5 0.6 0.3 0.5 0.7 1.0

33 EMD—Local 0.7 0.6 0.7 0.5 0.5 0.2 0.3 0.7 0.8 1.0

34 EMD—Corporate 0.8 0.7 0.7 0.5 0.7 0.2 0.4 0.6 0.9 0.7 1.0

35 Commodities 0.6 0.5 0.6 0.5 0.5 -0.1 0.1 0.4 0.4 0.5 0.5 1.0

36 Oil 0.5 0.5 0.4 0.4 0.5 -0.2 0.1 0.3 0.4 0.4 0.4 0.7 1.0

37 Industrial Metals 0.5 0.4 0.5 0.4 0.4 -0.1 0.0 0.3 0.4 0.4 0.4 0.7 0.4 1.0

38 Precious Metals 0.3 0.2 0.3 0.2 0.1 0.3 0.2 0.5 0.4 0.5 0.4 0.5 0.2 0.4 1.0

39 Agriculture 0.3 0.2 0.3 0.2 0.2 0.0 0.0 0.2 0.2 0.4 0.3 0.6 0.2 0.3 0.2 1.0

40 Global Listed Infrastructure 0.8 0.8 0.8 0.6 0.7 0.0 0.3 0.6 0.7 0.8 0.7 0.6 0.5 0.5 0.3 0.2 1.0

41 Global REITs 0.7 0.7 0.6 0.5 0.6 0.1 0.3 0.6 0.7 0.6 0.6 0.4 0.3 0.4 0.3 0.2 0.8 1.0

42 Global Hedge Funds 0.8 0.8 0.8 0.7 0.7 -0.2 0.2 0.5 0.6 0.6 0.6 0.6 0.5 0.6 0.3 0.3 0.8 0.7 1.0

43 US Private Real Estate 0.1 0.1 0.0 0.1 0.1 -0.1 0.0 0.1 0.1 0.1 0.0 0.2 0.2 0.1 -0.1 0.1 0.2 0.2 0.1 1.0

44 US Private Equity 0.2 0.3 0.2 0.2 0.2 -0.2 -0.1 0.1 0.1 0.2 0.2 0.2 0.2 0.2 0.0 0.0 0.3 0.2 0.3 0.3 1.0

Asset Classes Correlations continued




histories provides insightful information. The percentile of current expected return in relation to historical expectations indicates bullishness or bearishness relative to history. Our analysis shows that rank-adjusted results provide strong guidance in forecasting returns.

Building blocks model The building blocks model forecasts returns by summing three forecasts:

1. Dividend yield sourced from Bloomberg.

2. Earnings-per-share (EPS) growth rates, which are the average of bottom-up analyst forecasts from the I/B/E/S and top-down long-term GDP and inflation forecasts.

3. P/E expansion, which assumes that P/E will converge to its long-term average.

Specialty equitiesTo develop our expectations for specialty equities, we use regression models. The models identify relevant equity and commodity factors that drive the expected returns for each asset class. Based on the historic betas and alphas we construct forward- looking views that determine our expec-tations. We believe that within the specialty equity category, the returns in listed infrastructure and real estate investment trusts (REITs) should be in line with traditional equity indexes. Therefore, a main input to our specialty equity long-term return models is the relationship between those factors and the asset class indexes.

Fixed incomeYield Curve Shift Model. The main input to our fixed income return expectation is our yield curve shift (YCS) model. Principal component analysis of histor-ical data has shown that the expected returns for bonds are mainly driven by current yield level and parallel shift scenarios. Given a parallel shift scenario, the YCS model assumes the current yield curve will shift gradually to the target over ten years. The model also involves stressing the yield curve on a monthly basis using a random walk approach. The results include expected returns and the confidence intervals of the expected returns for the fixed income asset classes.

Major inputs into the model include:

1. Term structure (the shape of the yield curve)

2. Yield volatilities

3. Market structures (weights for different durations)

4. Expected shift scenarios

For corporate bonds and emerging- market debt instruments, we assume credit spreads will revert to their own long-term averages over a ten-year horizon. We estimate corresponding default and recovery rates based on the averages of their long-term history.

CommoditiesSpot Return and Roll Yield. We based our expected returns from commodities on two sources: spot return and roll yield. For spot return, we apply an infla-tion-adjusted model to forecast the spot price. We first calculate historical

This section provides an overview of the methodology and models we use to develop long-term capital market expectations (CMEs) for various asset classes, including equities, fixed income, commodities and alternatives. In total, our 2021 CMEs cover 54 asset classes and sub-asset classes, including 16 in equity, 25 in fixed income, five in commodities, five within currency and three in the alternative space. In addition, we deliver expecta-tions of three-month cash returns in six currencies.

Our long-term return expectations are driven by current valuations, analyst expectations, expected growth rates and expected economic environments.

EquitiesWe use two models for our equity return expectations. The benefit of using multiple models is that we consider both the absolute and relative forecasts (as in the residual income model). To develop our 2021 CMEs within tradi-tional equities, we used the “residual income” model and the “building blocks” model.

Residual income model The residual income model uses the relationship between price-to-book (P/B) ratios, historical return on equity (ROE), and forward-looking (one-year and two-year) ROE to determine expected returns. A higher forward ROE tends to contribute to a higher return expecta-tion. A lower P/B ratio typically indicates a higher return expectation.

In addition, we found that comparing expected returns relative to their own

Methodology



to currencies in countries with lower interest rates. We use our own forecast short-term cash rates for given countries as inputs.

Real Interest-Rate Parity Theory The real interest-rate differential between two countries drives the long-term exchange rate between them. We use our own forecasts for long-term inflation for the given countries.

AlternativesWe base our long-term forecasts for alternatives on efficiency and illiquidity premium assumptions. We consider the historical trend of the Sharpe ratio across various public and private assets.

To determine our expectation for private equity, we assumed an illiquidity premium, which is generally in line with a sample of institutional private market forecast assumptions. For our hedge fund return expectation, we combined our efficiency assumption and multi-factor regression models to forecast long run returns.

Economic forecastsWe collected GDP and inflation rates from multiple sources, including Oxford Economics, World Bank, OECD, IMF and other third parties. Our research team considers these external forecasts along with our own macro outlooks when ultimately producing our final economic forecasts. To determine the short-term (three-month) cash rate, we build out a forward rate model and use the Taylor rule-based cash forecast model. We include the current government bond yield curve, current inflation and GDP, long-term GDP and inflation expectations as inputs.

real commodity prices given their histor-ical inflation rates, and forecast real commodity price targets given the macroeconomic outlook, then add back the inflation expectation to get the final target spot price. For roll yield, we estimate historical roll yield for each commodity and take the long-term average for our forecasts.

CurrencyWe base our long-term foreign exchange assumptions on equal-weighting forecasts from three well-documented theories: purchasing power parity, interest-rate differential and real interest-rate parity.

Purchasing Power Parity Theory Exchange rates should change to create equilibrium ensuring that the same set of goods will cost the same if purchased with two different currencies. Inputs include OECD purchasing power parity and IMF calculations.

Interest-Rate Differential Theory Currencies in countries with high interest rates tend to appreciate relative



Indexes and proxies

Asset Class Market Proxy

EQUITY

Global Equity MSCI AC World Daily TR Net

Developed-Market Equity MSCI Daily TR Gross World Local

US Large Cap MSCI Daily TR Gross USA Local

Canada MSCI Daily TR Net Canada

EAFE MSCI EAFE Net Total Return USD Index

EMU MSCI Daily TR Gross EMU USD

UK MSCI Daily TR Net UK USD

Pacific ex Japan MSCI Pacific ex Japan Net Total Return USD Index

Japan MSCI Japan Net Total Return USD Index

Australia MSCI Daily TR Net Australia USD Index

Emerging Markets MSCI Emerging Net Total Return USD Index

China MSCI China Net Total Return USD Index

Specialty Equity

Global Listed Infrastructure S&P Global Infrastructure Total Return Index

US Infrastructure MSCI USA Infrastructure Net Total Return Index

Global REITs S&P Global REIT USD Total Return Index

US REITs S&P USA REIT USD Total Return Index

FIXED INCOME

Global Developed- Market Government

FTSE World Government Bond Index (WGBI) USD

US Government Bloomberg Barclays US Treasury Total Return Unhedged USD

Euro Government FTSE EMU GBI USD

UK Government Bloomberg Barclays Sterling Gilts Total Return Index Value Unhedged USD

Japan Government Bloomberg Barclays Global Japan Total Return Index Value Unhedged USD

Australia Government Bloomberg Barclays Global: Australia Total Return Index Value Unhedged USD

Canada Government Bloomberg Barclays Capital Global: Canada Total Return Index Value Unhedged USD


GLOBAL CREDIT

Global Investment- Grade Credit

Bloomberg Barclays Global Agg Corporate Total Return Index Value Unhedged USD

Investment Grade USD Bloomberg Barclays US Corporate Total Return Value Unhedged USD

Investment Grade EUR Bloomberg Barclays Euro Aggregate Corporate Total Return Index Unhedged USD

Investment Grade GBP Bloomberg Barclays Sterling Aggregate Corporate TR Value Unhedged USD

Global Corporate High Yield

Bloomberg Barclays Global High Yield Total Return Index Value Unhedge

US High Yield Bloomberg Barclays US Corporate High Yield Total Return Index Value Unhedged USD

Euro High Yield Bloomberg Barclays Pan-European High Yield Total Return Index Value Unhedged USD

UK High Yield Bloomberg Barclays High Yield (GBP) ex Fin Total Return Index Unhedged USD

US High Yield Loans Credit Suisse Leveraged Loan Total Return

US Securitized

US MBS Bloomberg Barclays US MBS Index Total Return Value Unhedged USD

Municipal Bonds

US Munis Bloomberg Barclays Municipal Bond Index Total Return Index Value Unhedged USD

Inflation Linked

Global inflation linked Bloomberg Barclays Global Inflation-Linked Total Return Index Value Unhedged USD

TIPS USD Bloomberg Barclays US Govt Inflation-Linked All Maturities Total Return Index

Euro inflation linked EUR Bloomberg Barclays Euro Inflation-linked 5-10 Yrs TR Unhedged USD

UK inflation linked GBP Bloomberg Barclays UK Inflation Linked Bonds Total Return Unhedged USD

Emerging Markets Goverments

EMD—Hard Bloomberg Barclays Emerging Markets Sovereign TR Index Value Unhedged USD

EMD—Local J.P. Morgan GBI-EM Global Diversified Composite Unhedged USD

EMD—Corporate Bloomberg Barclays: EM USD Aggregate: Corporate




ALTERNATIVES

Commodities

Oil Bloomberg WTI Crude Oil Subindex Total Return

Industrial Metals Bloomberg Industrial Metals Subindex Total Return

Precious Metals Bloomberg Precious Metals Subindex Total Return

Agriculture Bloomberg Agriculture Subindex Total Return

Global Gold Miners FTSE Gold Mines Index TR USD

Global Hedge Funds Hedge Fund Research HFRI Fund Weighted Composite Index

US Real Estate NCREIF Property Index

US Private Equity Cambridge Associates US Private Equity Index

Indexes and Proxies listed here only represent a subset of our total asset classes, hedging treatments, and currencies covered.



About Franklin Templeton Investment Solutions

At Franklin Templeton Investment Solutions, we translate a wide variety of investor goals into portfolios powered by Franklin Templeton’s best thinking around the globe. We serve a variety of institutional clients, ranging from sovereign wealth funds to public and private pension plans in addition to retail multi-asset clients around the world.

The hallmark of our approach is a central forum—the Investment Strategy & Research Committee—which generates a top-down view across asset classes and regions, and connects and synthesizes the bottom-up sector and regional insights of the global investment teams at Franklin Templeton.

The FTIS research team features a group of highly specialized quantitative analysts dedi-cated to the pursuit of new sources of return, strategic diversification and calibrated volatility management, allowing us to apply the highest level of innovation in our client portfolio solutions. In addition to the quantitative research behind this paper, the team is focused on volatility strategies, smart beta strategies and risk premia strategies.

Primary contributors to this issue

Chandra Seethamraju, Ph.D.Co-Head Systematic Strategies Portfolio Management

Franklin Templeton Investment Solutions

Gene Podkaminer, CFAHead of Research

Chair of Investment Strategy & Research Committee

Franklin Templeton Investment Solutions

Vaneet ChadhaSenior Research Analyst

Stephanie Chan, CFASenior Research Analyst

Michael Kerwin, CFASenior Research Analyst

Richard Hsu, CFASenior Research Analyst

Hao Li, CFASenior Research Analyst

Laurence LinklaterSenior Research Analyst

Melissa MayorgaSenior Research Analyst

Chris Ratkovsky, CFASenior Research Analyst

Miles Sampson, CFASenior Research Analyst

Kim Strand, CFAHead of Fundamental Research and ESG Integration

Kent Shepherd, CFA, CICSenior Client Portfolio Manager

Mike Greenberg, CFA, CAIAPortfolio Manager

Matthias HoppePortfolio Manager

Michael Dayan, CFALead Portfolio Analyst

Manognya Deepthi GorthyResearch Analyst

Dominik HoffmannResearch Analyst

Ian WestleyResearch Associate



Notes



WHAT ARE THE RISKS?

Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size, lesser liquidity and lack of established legal, political, business, and social frameworks to support securities markets. Such investments could experience significant price volatility in any given year. Derivatives, including currency management strategies, involve costs and can create economic leverage in a portfolio, which may result in significant volatility and cause the portfolio to participate in losses (as well as enable gains) on an amount that exceeds the portfolio’s initial investment. Investing in the natural resources sector involves special risks, including increased susceptibility to adverse economic and regulatory develop-ments affecting the sector—prices of such securities can be volatile, particularly over the short term. Some strategies, such as hedge fund and private equity strategies, are available only to pre-qualified investors, may be speculative and involve a high degree of risk. An investor could lose all or a substantial amount of his or her investment in such strategies. Real estate securities involve special risks, such as declines in the value of real estate and increased susceptibility to adverse economic or regulatory developments affecting the sector.

Copyright © 2020 Franklin Templeton Investments. All rights reserved. CMEUS_4Q20_0221

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This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. All investments involve risks, including possible loss of principal.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verifi ed, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user.

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2021 capital market expectations continued support for

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