With this outlook, we will focus on our longer-term view of the capital markets and the implications. While many investment gurus of the past have seen their fortunes wiped out by believing that “it’s different this time”, we do believe the world of portfolio management has changed and is becoming more challenging. The main culprits of this changing environment are the low yields in the fixed income market, and low equity risk premiums. Fixed Income has always been an integral part of a balanced portfolio, lowering the portfolio’s volatility as well as providing solid returns. Unfortunately, those days are behind us. We expect the broad Canadian bond Universe to deliver no more than 2.5% over the next decade, and just as important, that return will come with increased risk. As a result, fixed income in one’s portfolio will no longer provide the same risk/return benefits as it did over the past four decades.
Additionally, stocks are not expected to provide the same returns over the next decade as they’ve provided in the past. We expect stocks to return somewhere in the 6-7% range over the next decade. What does this all mean? Over the past 40 years, a typical 60% stock/40% bond portfolio returned about 8-10% per year. Going forward, that same asset mix will return about 5-6% with even more risk. In other words, investors will need to take on more risk in order to generate significantly less returns.
Individual investors are not the only ones impacted by this new reality. Pension plans, Endowments, Foundations, etc. are all facing this same dilemma. A few of them saw the “writing on the wall” and have started to shift their asset allocations as a result.
Many people are unaware that the Canada Pension Plan (CPP) is one of the most respected pension plans in the world. They are an industry leader in how pension money is being managed. In the late 2000’s the CPP was invested almost entirely in the public markets (both stocks and bonds). Today, the CPP has over 40% exposure to non-public market assets. Public market assets trade on an exchange, like the Toronto Stock Exchange. Non-public market assets tend to be privately held or don’t trade on any official exchange. There are trade-offs to both. Public market assets have tremendous liquidity. They can be bought and sold at a moment’s notice, but that “liquidity” comes with a price discount and increased volatility, as they are subject to the short-term vagaries of market sentiment. On the other hand, private assets are not very liquid, but that comes with the benefit of lower volatility, and possibly higher returns.
When individuals think about investing, they tend to think stocks, bonds and possibly real estate. The truth is that there are many other assets available to invest in, that most of us aren’t aware of. While many are familiar with investing directly in real estate, or private equity, many are unaware that one can now invest in physical assets such as wind farms, solar farms, water treatment plants, airports, toll roads, farmland or timberland.
We’ve spent a considerable amount of time over the past several years contending with the same questions that the CPP has had: is it possible to enhance portfolio returns, while reducing overall portfolio risk? Comparable to the CPP’s conclusion, we believe that embracing non-public market assets will achieve these goals. We’ll be introducing institutional quality investments (investments only available to large institutions) such as infrastructure, agriculture, private real estate and private equity into your portfolios which will help deliver what we believe every investor seeks – better returns with less risk.
The launch of our Strategic Income Pool has been a successful step in this direction by providing a stable price with a 4-6% annual yield. The Strategic Income Pool is a well diversified pool comprised of various income producing assets such as bank loans, private debt, mortgage debt, and factoring, amongst others – all investments that are not publicly traded. The income generated by the pool will be superior to what one can achieve in a government of Canada bond.
In summary, based on market outlooks from various sources, and our own research on the changing investment landscape, we believe that it is imperative that we expand our investment universe. As we look to provide our clients with the investment returns they require, while also reducing the volatility of those returns, we will be following the path of some of the world’s most successful endowment and pension funds. As many investors well know, there are very limited conclusions that we can draw from a single year of performance. Indeed, such superficial focus can lead to unwise or even dangerous conclusions. Had this past year’s return been significantly higher or lower, it still would not deflect us from the path we are pursuing. We are excited about the future and look forward to continuing this conversation with you.