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 of varying asset allocations to provide 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 2024.
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 list of approved asset classes currently 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 |
- Expected return: the average annual percentage return we expect to be generated 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 returns 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 financial models that attempt to predict the future path of interest rates, inflation, employment, and economic growth. Some firms develop capital market assumptions solely for their own internal purposes, but many publish reports detailing their findings. We review publicly-available long-term capital market assumptions from trusted sources each year and consolidate them into our own set of assumptions. In some 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 2024 Long-Term Capital Market Assumptions
After completing the data collection process outlined above, we’ve updated our long-term capital market assumptions for 2024. While it is incredibly difficult to predict future results with a high degree of certainty, these assumptions represent our best guess of the average annual returns (before fees or taxes) that a Canadian investor can reasonably expect to achieve when investing in various asset classes over the long term (i.e. 10+ years):
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
Our latest return assumptions are relatively stable on a year-over-year basis, with all asset classes within +/- 0.5% of their values in 2023. The chart below compares the expected returns in our 2024 long-term capital market assumptions against the prior year and displays the year-over-year change for each asset class:
Conclusion
The purpose of this article is to provide insight into how we arrive at our long-term capital market assumptions and how the assumptions serve as the building blocks for our investment portfolios. After significant increases were applied across all asset classes in 2023, our long-term return assumptions are relatively unchanged in 2024 and the go-forward prospects for clients’ investment portfolios remain attractive. If you have any questions or would like to discuss this topic in more detail, please contact your advisor.