After more than a decade of steady inflation, low interest rates, and attractive equity market returns, 2022 felt like the end of an era. Inflation spiked, central banks aggressively raised interest rates, and the debt-fuelled speculative investment party that kicked into overdrive during the pandemic came to an abrupt end. Most asset classes experienced negative returns for the year, with bonds performing uncharacteristically poorly. Read on to learn more about the year that was and what might lie ahead for investors.

2022 Performance

Given our passive investment management philosophy, we don’t spend a lot of time analyzing the economic cycle or forecasting short-term returns for individual securities, sectors, or countries. Instead, we focus on long-term (i.e. 10+ years) return assumptions for broad asset classes and construct model portfolios that we expect will generate efficient returns in the context of modern portfolio theory.

Despite having a long-term focus, monitoring the performance of capital markets over short and medium time frames remains useful to assess whether investment returns seem consistent with longer-term assumptions. Chart 1 outlines the returns for various benchmarks in 2022 while Chart 2 demonstrates how combining those returns in different proportions (what we call our model portfolios) impacted results:

As demonstrated in Charts 1 and 2, the past year was a difficult one for investors with the majority of asset classes experiencing negative returns. Aside from parking all of one’s assets in cash or gold, there was really no safe place to hide in 2022. For more details on why this was the case, click/tap on the following topics to expand:

  • Inflation (+6.8%) was one of the biggest economic stories of 2022. Continuing an upward trajectory that first started in early 2021, a combination of factors – the Russian invasion of Ukraine, skyrocketing energy costs, and China’s zero-COVID policy among others – contributed to intensifying inflationary pressures in 2022. The Canada All-Items CPI index peaked at a rate of 8.1% in June – the largest yearly change since January 1983 – and by the end of the year had risen by 6.8% (comparing November 2022 prices against November 2021 prices). We are hopeful that inflation has now peaked and will continue to normalize throughout 2023, partly as a result of many temporary pressures resolving, but also due to seven consecutive interest rate hikes by the Bank of Canada that sent the target for the overnight rate from 0.25% to 4.25% in 2022. Higher interest rates have already had a cooling effect on rate-sensitive sectors like housing, and the full impact should continue working its way through the broader economy in 2023. This will put downward pressure on inflation – the Bank of Canada’s goal – albeit at the cost of slower economic growth and higher unemployment.
  • The U.S. Dollar (+6.8%) strengthened against the Canadian dollar in 2023, partially offsetting the negative investment return of assets denominated in U.S. dollars. A stronger U.S. dollar increases the value of U.S. investments in a Canadian investor’s portfolio once those assets are converted back to the investor’s home currency (i.e. Canadian dollars). Historically, the U.S. dollar strengthens against the Canadian dollar during periods of economic turmoil, and for this reason we avoid hedging the currency of foreign investments in our model portfolios. Maintaining exposure to the U.S. dollar is expected to reduce the price volatility of U.S. dollar-denominated assets over the long term, with 2022 being a good example of the theory in action.
  • Universe Bonds (-11.2%) experienced a negative return for the second year in a row and the magnitude of the decline in 2022 was uncharacteristically large. Universe Bonds (which include short-, medium-, and long-term bonds issued by Canadian governments and large corporations) have historically experienced negative returns in about 1/10th of years, and when negative results have occurred they were typically much more moderate (e.g. -2.5% in 2021, -1.2% in 2013). This year’s poor performance was a result of rising interest rates, something we wrote about in more detail back in May.
  • Canada Equity (-5.8%) performed well in 2022 relative to other equity asset classes, although this was little consolation given that its performance was still negative. Canadian Equity outperformed other geographies due to its heavy weighting to the energy sector which returned an impressive 54.0% for the year, offset by poor performance in Health Care (-57.0%), Information Technology (-35.5%), and Real Estate (-21.5%).
  • U.S. Equity (-14.0%) was the second worst performing asset class in 2022, which is not entirely surprising following previous three straight years of exceptional double-digit returns. A large weighting to the hard-hit technology sector dragged down performance, although the strength of the U.S. dollar helped offset a significant portion of the losses for Canadian investors. Without accounting for U.S. dollar strength, U.S. Equity performance would have been -19.5% in 2022.
  • Emerging Markets Equity (-14.3%) was the worst performing asset class in 2022, influenced by its large exposure to Chinese stocks (-16.3%) as well as a small exposure to Russian stocks which were essentially written off and removed from the emerging markets index in response to Russia’s invasion of Ukraine. This asset class has the highest long-term expected return but that is also associated with the highest expected level of risk (i.e. price variation), as demonstrated by 2022’s results.
  • Global Low Volatility Equity (-3.8%) was the best performing equity asset class in 2022. The objective of Global Low Volatility Equity is to track the investment results of companies that, in aggregate, have lower volatility (i.e. price variation) characteristics relative to the broader market. In a period where most equities are declining substantially, the Global Low Volatility Equity asset class should outperform, as was the case in 2022.
  • Gold (+6.4%) was a performance stand out in 2022 as the only asset class other than cash to generate positive returns. Clients invested in model portfolios with an allocation to gold received a valuable source of diversification in a year where nothing else performed well.

A model portfolio is a set of asset class allocations (or weightings) used to guide the investment of a client’s money at a high level, before any security-specific implementation decisions are made. Review our 2022 Model Portfolios article for additional details.

The 2022 model portfolio performance results presented in Chart 2 look a bit unusual. Typically, we would expect a linear relationship between model portfolio risk level and model portfolio return (i.e. in a bad year like 2022, the Risk 0 model would have the best relative result and the Risk 10 model would have the worst result). This relationship held true for our Cash and Conservative model portfolios in 2022, but was not the case for our Balanced or Aggressive model portfolios:

  • Balanced Model Portfolios include those with a Risk Level of 4, 5, 6, or 7. Despite covering a wide range of asset allocations (e.g. the Risk 4 model has 40% equity exposure while the Risk 7 model has 70% equity exposure), the performance of all four balanced models was remarkably similar in 2022 (about -11.5% for models without gold and about -10.8% for models with gold). How could this be? The main differentiator between the Balanced models is their relative allocations to fixed income vs. equity, but both of these broad asset classes experienced similar results in 2022 (Universe Bonds returned -11.2% while the average return across equity asset classes was -11.9%). Therefore, while the Risk 4 model portfolio has 30% less exposure to equity (-11.9% return) than the Risk 7 model, it has 30% more exposure to fixed income (-11.2% return), leading to nearly identical returns across all Balanced model portfolios.
  • Aggressive Model Portfolios include those with a Risk Level of 8, 9, or 10. These are the highest risk model portfolios we offer and contain equity exposures of 80% (Risk 8), 90% (Risk 9), and 100% (Risk 10). Despite these high equity exposures, the Aggressive models managed to outperform the more conservative Balanced models in 2022. How? The answer lies in the source of incremental equity exposure for the Aggressive model portfolios, which is primarily created through the addition of Global Low Volatility Equity. In 2022, Global Low Volatility Equity (-3.8% return) substantially outperformed both fixed income (-11.2% return) and traditional equity (-11.9% aggregate return), so the Aggressive model portfolios, with their allocation to Global Low Volatility Equity, had better performance.

Viewed in isolation, the 2022 model portfolio returns seem somewhat inconsistent with their respective risk levels. However, with a better understanding of the differences between our model portfolios and the unique performance drivers in 2022, we think the results are reasonable. We also remain confident that the long-term performance results of the model portfolios will maintain a linear relationship with model portfolio risk levels.

5-Year Performance

We always encourage investors to discount year-to-year swings (whether they are positive or negative) and instead focus on the longer term. Charts 3 and 4 therefore present capital market and hypothetical model portfolio performance over the past 5 years:

Despite the poor returns experienced in 2022, the majority of benchmarks presented in Chart 3 experienced positive annualized returns over the 5-year period ending December 31, 2022. Many of the medium-term benchmark returns are in line (i.e. +/- 2%) with our most recent long-term capital market assumptions (represented by a vertical blue line for each benchmark), but there are some notable exceptions:

  • Universe Bonds (+0.3%) experienced back-to-back years of negative returns in 2021/2022 as a result of rising inflation and actions by the Bank of Canada to aggressively raise interest rates. This resulted in an annualized return of just 0.3% over the past five years, which is substantially lower than our most recent long-term return assumption of 2.7%. The good news is that Universe Bonds now provide a much higher yield compared to the start of 2022 – currently around 4% – so the asset class is likely to provide more attractive returns over the years ahead.
  • U.S. Equity (+10.2%) experienced incredible returns for the three years prior to 2022. As a result, even after accounting for 2022’s lacklustre performance, U.S. equity has earned an annualized return of 10.2% over the past five years. This is substantially higher than our most recent long-term return assumption of 7.0%, which incorporates an expectation for U.S. equity returns to be more moderate going forward.
  • International Equity (+2.9%) returns have lagged over the past five years, earning an annualized return of just 2.9% which is below our most recent long-term return assumption of 7.4%. However, in last year’s annual review the 5-year return for this asset class was actually above its long-term return assumption, meaning the trailing 5-year return has swung dramatically in a single year. This highlights the potential volatility of historical returns even over medium time frames. We will monitor this asset class over the coming years and expect it to trend closer to the long-term return assumption over time.
  • Emerging Markets Equity (+0.2%) was the worst performing asset class over the past five years, earning an annualized return of just 0.2%. This is well below our long-term return assumption of 9.2% and represents the largest shortfall for an asset class compared to its long-term assumption. However, in last year’s annual review the 5-year return for this asset class was relatively close to its long-term return assumption, meaning the trailing 5-year return has swung dramatically in a single year. Given the high expected risk (i.e. price volatility) for Emerging Market Equity, we are not yet concerned by the current deviation from expectations. The underperformance of Emerging Market Equity over the medium term is largely a China story and there are some encouraging economic signs for that region as we head into 2023. We will monitor this asset class over the coming years and expect it to trend closer to the long-term return assumption over time.
  • Gold (+8.6%) has experienced impressive returns over the past five years, exceeding our long-term return assumption of 4.4%. The price of the precious metal is historically very volatile so it is not surprising to see large deviations from our long-term return assumption in this asset class. Gold is an optional component in some of our model portfolios, included for its diversification benefits, not because it is expected to provide consistently high (or stable) returns.

Chart 4 demonstrates that the hypothetical 5-year performance results of our model portfolios follow a more traditional pattern in comparison to the slightly unusual return pattern experienced in 2022 (see Chart 2). As would typically be expected, we see a linear relationship between model portfolio risk level and model portfolio return, with higher risk portfolios experiencing higher returns over the past five years.

Firm Highlights

2022 was the first full year that High Level Wealth Management operated as a registered Portfolio Manager. Admittedly, we haven’t had great timing for starting up and trying to grow a small business in the financial services industry, but thankfully we continued to welcome new clients throughout the year and grew our assets under management by 80% compared to December 2021.

We were impressed by the general composure of our clientele throughout the year despite being tested repeatedly by the markets in 2022. While no one enjoys a year of poor investment returns, a year like 2022 also creates the opportunity for future growth for those that are committed to a long-term, passively-managed investment strategy.

From an operational perspective, our biggest undertaking in 2022 was the introduction of two sustainable investment strategies. Along with our standard strategy, we are happy to now offer a wider range of investment options to better align client portfolios with client values. Over the course of 2023, we will be discussing these sustainable investment strategies with each of our clients, but if this topic is something you are passionate about, we would be happy to have a discussion with you sooner.

Looking Ahead

While 2022 marked the abrupt end to an era characterized by steady inflation, low interest rates, and debt-fuelled speculative investments, we remain optimistic about 2023 and the years beyond. While the global economy may continue to slow and various regions could fall into recession over the coming months, much of the potential bad news now seems to be priced into capital market valuations. If inflation continues to normalize, central banks should stop raising interest rates – or even contemplate rate cuts – and good economic news could once again become more plentiful.

As a firm, High Level Wealth Management has a number of priorities in 2023:

  • Our client base has grown enough to now support the additional costs of more sophisticated software tools. We therefore plan to review our financial planning software in the first half of 2023 with the goal of implementing a more advanced, client-friendly tool.
  • We made many small enhancements to the My High Level Wealth client portal throughout 2022 and we will continue adding features in 2023. Improving the user experience on mobile devices remains a priority, as does converting several reports from standalone spreadsheets to interactive client portal modules. Your feedback is always appreciated, so let us know if you have any ideas or opinions.
  • Introducing our services to potential new clients remains our top priority. There are a variety of business models in the financial services industry with practitioners of varying skill levels all calling themselves financial advisors. It is a crowded market, but we hope to stand out based on our professional, trustworthy, client-focused service, which we offer at a fair price. If you know someone that might benefit from our services, please let them know about us.

The past year has been another challenging one for many and we sincerely appreciate the continued support of our clients, family, and friends. We wish everyone a healthy and prosperous year ahead and we look forward to playing a part in your continued success.

Footnotes

Data sources:

Inflation & Currency
Inflation: Canada All-Items CPI (November reading of each period)
U.S. Dollar: Bank of Canada CAD/USD Daily Rate
International Currencies: Bank of Canada Daily Nominal Canada Effective Exchange Rate excluding the U.S. Dollar (Inverted)

Fixed Income
Cash: S&P Canada Treasury Bill Index
Short-term Bonds: Solactive Broad Canadian Short Term Bond Universe Index
Universe Bonds: Solactive Broad Canadian Bond Universe Index

Equity
Canada: S&P/TSX Capped Composite Index
U.S.: CRSP US Total Market Index (CAD)
International: MSCI EAFE Investable Market Index (CAD, net of withholding taxes)
Emerging Markets: MSCI Emerging Markets Index (CAD, net of withholding taxes)
Global Low Volatility: MSCI All Country World Minimum Volatility Index (CAD, net of withholding taxes)

Alternatives
Gold: LBMA Gold Price (CAD, AM Price)

It is not possible to invest in a benchmark or index directly and returns do not reflect the transaction costs or management fees that an investor would incur when investing in a financial product, such as an exchange-traded fund, that attempts to track the performance of a benchmark or index.

Data sources:

Model portfolio returns are calculated by averaging the asset class returns presented in Chart 1, weighted by each model portfolio’s asset allocation targets. Review our 2022 Model Portfolios article for additional details.

Returns presented are hypothetical because it is not possible to invest in a benchmark or asset class index directly. The returns presented do not reflect the transaction costs or management fees that an investor would incur when investing in a financial product, such as an exchange-traded fund, that attempts to track the performance of a benchmark or asset class index.

Clients’ actual returns will vary based on their management fees and the timing of cash flows into or out of their accounts. Model portfolio returns also assume that asset class weightings are held constant while in practice an account’s asset allocation may deviate from targets within a predetermined range before being rebalanced.

Data sources:

Inflation & Currency
Inflation: Canada All-Items CPI (November reading of each period)
U.S. Dollar: Bank of Canada CAD/USD Daily Rate
International Currencies: Bank of Canada Daily Nominal Canada Effective Exchange Rate excluding the U.S. Dollar (Inverted)

Fixed Income
Cash: S&P Canada Treasury Bill Index
Short-term Bonds: Solactive Broad Canadian Short Term Bond Universe Index
Universe Bonds: Solactive Broad Canadian Bond Universe Index

Equity
Canada: S&P/TSX Capped Composite Index
U.S.: CRSP US Total Market Index (CAD)
International: MSCI EAFE Investable Market Index (CAD, net of withholding taxes)
Emerging Markets: MSCI Emerging Markets Index (CAD, net of withholding taxes)
Global Low Volatility: MSCI All Country World Minimum Volatility Index (CAD, net of withholding taxes)

Alternatives
Gold: LBMA Gold Price (CAD, AM Price)

It is not possible to invest in a benchmark or index directly and returns do not reflect the transaction costs or management fees that an investor would incur when investing in a financial product, such as an exchange-traded fund, that attempts to track the performance of a benchmark or index.

Data sources:

Model portfolio returns are calculated by averaging the asset class returns presented in Chart 3, weighted by each model portfolio’s asset allocation targets. Review our 2022 Model Portfolios article for additional details.

Returns presented are hypothetical and do not reflect actual investment returns earned by clients of High Level Wealth Management – our firm was granted registration in the category of Portfolio Manager in early 2021 and did not manage client investments prior to that time. We present hypothetical 5-year model portfolio performance to illustrate how our model portfolios might have performed (before fees) over a medium historical time frame. It is not possible to invest in a benchmark or asset class index directly and the returns presented do not reflect the transaction costs or management fees that an investor would incur when investing in a financial product, such as an exchange-traded fund, that attempts to track the performance of a benchmark or asset class index.

Clients’ actual returns will vary based on their management fees and the timing of cash flows into or out of their accounts. Model portfolio returns also assume that asset class weightings are held constant while in practice an account’s asset allocation may deviate from targets within a predetermined range before being rebalanced.