Understanding What Really Drives Expected Investment Returns

Key Takeaways

• Risk perception explains ~90% of return expectation variation.
• Risk quantity, not risk aversion, drives long‑term premium shifts.
• High yields viewed as risk compensation, not undervaluation.
• Disagreement still driven by risk, but mispricing matters more.
• Study covers $37 trillion assets across 45 institutions.

Summary

A new October 2025 paper examined Capital Market Assumptions from 45 major institutions that manage roughly $37 trillion and advise over 70% of U.S. public pensions. Analyzing forecasts from 2001‑2022, the authors found that perceived risk explains about 90% of the time‑variation in expected market returns, dwarfing the role of mispricing. Risk quantity—not investors’ risk appetite—drives long‑term premium shifts, while high yields are seen as compensation for risk rather than bargains. Disagreement among firms still hinges on risk, but mispricing views play a larger part.

Pulse Analysis

The research taps into a rich dataset of Capital Market Assumptions—detailed forecasts of returns, volatilities and correlations that institutional investors rely on for strategic planning. By covering more than two decades of outlooks from the world’s largest asset managers and consultants, the authors provide a rare longitudinal view of how expectations evolve. Their methodology isolates two drivers: perceived mispricing and subjective risk premia, allowing a clear attribution of return forecasts to underlying beliefs rather than external market shocks.

Findings reveal that subjective risk, especially the perceived magnitude of future volatility, accounts for roughly nine‑tenths of the variation in expected market returns. This dominance of risk quantity over risk aversion suggests that long‑run portfolio decisions are anchored in how risky assets are expected to behave, not in how much investors dislike risk. Consequently, when yields rise—whether on equities, bonds, private equity or real estate—professionals interpret the move as a risk premium demand, not a signal of cheapness. This risk‑first lens challenges the conventional narrative that institutional investors constantly hunt for undervalued opportunities.

Even when firms disagree on return forecasts, risk remains the primary driver, though mispricing considerations gain relative importance. The implication for the broader market is clear: asset‑pricing models and investment strategies should prioritize accurate risk assessment and covariance estimation. For practitioners, integrating these insights means emphasizing scenario analysis around risk volatility and treating high yields as compensation cues rather than buying opportunities. As the investment landscape continues to evolve, understanding the subjective risk premium will be essential for aligning expectations with real‑world outcomes.