As a portfolio manager, our mission is to help clients allocate their money to investment portfolios that provide efficient risk-adjusted returns over the long-term. Given the ever-expanding list of potential investment products, how do we determine the composition of client portfolios and select the securities to include? Our portfolio construction process – something we review each year – consists of four main steps:

  1. Creating long-term capital market assumptions for various asset classes.
  2. Developing model portfolios with varying asset allocations and a range of risk/return characteristics.
  3. Reviewing the universe of available investment products and determining which ones to approve for use in our model portfolios.
  4. Mapping approved investment products to model portfolios across various account types to minimize costs and taxes.

In this article we will focus on the first step of the portfolio construction process and discuss our updated long-term capital market assumptions for 2022.

What are Long-Term Capital Market Assumptions?

You can think of long-term capital market assumptions as the building blocks of an investment portfolio. To begin, we identify a list of asset classes that we might want to include in our client portfolios. Our current list of approved asset classes includes:

Fixed IncomeEquity (Stocks)Alternatives
Canada – CashCanadaGold
Canada – Short-term BondsUnited States
Canada – Universe BondsInternational – Developed Markets
International – Emerging Markets
Global – Low Volatility

For each asset class we then come up with a set of assumptions (i.e. forward-looking projections) for:

  • Expected return: the average annual percentage return we expect to generate over the long term (i.e. 10+ years).
  • Expected risk: a measure of the expected year-to-year volatility of the expected return.
  • Expected correlation: the degree to which the values of any two asset classes are expected to move up or down in relation to each other.

Developing long-term capital market assumptions is a complex task typically undertaken by large institutional investors with teams of experts that develop financial models aimed at predicting the future path of interest rates, inflation, employment, and economic growth. These models are used to develop forward-looking assumptions for the return, risk, and correlation of various asset classes. Some firms develop capital market assumptions for their own internal purposes, but many firms publish reports detailing their findings. Each year we survey the publicly-available long-term capital market assumptions from a range of trusted sources and consolidate them into our own set of assumptions. In rare circumstances we apply professional judgement to the consolidated data and make adjustments where we believe it is warranted, but for the most part we just let the data speak for itself.

Our 2022 Long-Term Capital Market Assumptions

After completing the data collection process outlined above, we’ve updated our long-term capital market assumptions for 2022. While it is difficult to predict the future with a high degree of certainty, these assumptions represent our best guess of the returns (before fees or taxes) that a Canadian investor can reasonably expect to achieve over the long-term by investing in various asset classes:

A useful way to visualize long-term capital market assumptions is to plot the intersection of expected return and expected risk for each asset class on a scatter chart. As demonstrated below, this highlights the clear relationship between return and risk – in order to earn a higher return, an investor generally needs to be willing to accept more risk:

Changes to Expected Returns

As discussed more thoroughly in our Commentary on Recent Capital Markets Performance (May 12, 2022), capital markets have experienced significantly negative year-to-date performance in 2022. While negative returns can be both painful and stressful in the moment, an often-overlooked side benefit is the improvement this makes to future return expectations. All else being equal, to the extent that fixed income and equity valuations have decreased substantially this year, those asset class categories should be more attractive investments going forward.

The chart below compares the expected returns in our 2022 long-term capital market assumptions against the prior year, highlighting the positive/negative changes for each asset class:

Higher Returns Expected for Fixed Income
Given the dramatic rise in interest rates this year, it is not surprising to see improvements to the long-term expected returns for fixed income asset classes. Compared to last year, the expected return for Short-term Bonds has improved by 0.7% while the expected return for Universe Bonds has improved by 0.8%. These are encouraging developments for fixed income investors who have been grappling with record low yields in recent years.

Higher Returns Expected for U.S. Equity
Of all the asset classes we include in client portfolios, U.S. Equity had the worst performance for the first half of 2022 (returning -20.1% in Canadian dollar terms). The substantial year-to-date decline for U.S. Equity has brought down its valuation metrics, which are now more in line with historical averages. Current valuation metrics therefore provide a more attractive starting point for forward-looking return projections in our 2022 long-term capital market assumptions, with the expected return for U.S. Equity improving by 0.9% compared to last year.

Higher Returns Expected for Global Low Volatility Equity
Given that U.S. Equity makes up a large portion (approximately 60%) of the Global Equity asset class, the same factors leading to an improvement in expected return for U.S. Equity have had a knock-on effect to the expected return for Global Low Volatility Equity. Compared to last year, the expected return for Global Low Volatility Equity has improved by 0.9%.


Hopefully this article has provided insight into how we arrive at our long-term capital market assumptions and how these assumptions serve as the building blocks for our investment portfolios. If you have any questions or would like to discuss the topic in more detail, please contact your advisor. To learn about the next step of our portfolio construction process, read the next article in this series: 2022 Model Portfolios.