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. To achieve this, we conduct an annual review of our portfolio construction process, consisting of four main steps:
- Creating long-term capital market assumptions for various asset classes.
- Developing model portfolios with varying asset allocations to cover a range of risk/return characteristics.
- Reviewing the universe of available investment products and determining which ones to approve for use in our model portfolios.
- Mapping approved investment products to model portfolios across various account types to minimize costs and taxes.
This article focuses on the first step of the portfolio construction process: our updated long-term capital market assumptions for 2023.
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 client portfolios. Our current list of approved asset classes includes:
|Fixed Income||Equity (Stocks)||Alternatives|
|Canada – Cash||Canada||Gold|
|Canada – Short-term Bonds||United States|
|Canada – Universe Bonds||International – Developed Markets|
|United States – High Yield Bonds||International – Emerging Markets|
|Global – Low Volatility|
This year we started including assumptions for U.S. High Yield Bonds for the first time. High yield bonds are debt securities that typically pay higher interest rates because they are issued by corporations that have lower credit ratings than investment-grade bonds. We’ll have more to say about this new asset class in the near future.
For each approved asset class, we 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. Some firms develop capital market assumptions for their own internal purposes, but many publish reports detailing their findings. Each year we survey the publicly-available long-term capital market assumptions from 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 2023 Long-Term Capital Market Assumptions
After completing the data collection process outlined above, we’ve updated our long-term capital market assumptions for 2023. 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 on average when investing in various asset classes over the long term (i.e. 10+ years):