Financial advisors and investors will likely have to take on more risk in their investment portfolios in the coming decade if they want to achieve the rates of return they have been accustomed to over the past 20 years.
That’s because the annual returns in a range of asset classes that are core to Canadian portfolios – including Canadian equities, government and investment-grade bonds – are projected to be lower over the next seven to 10 years, according to money managers at Franklin Templeton Investments Corp. They presented some of the key insights from the firm’s Capital Market Expectations report at its 2020 Global Investment Outlook event in Toronto last month.
To produce the report, the firm examined the expected rates of returns of more than 50 asset classes by looking closely at a variety of factors, from historical risk premia, economic growth and inflation prospects to debt levels, populism and how policy-makers are expected to respond to the next economic downturn.
Notably, Franklin Templeton predicts that Canadian government and investment-grade corporate bonds will lag past rates of return dramatically. That means advisors and investors will likely have to adopt a more aggressive asset mix to meet their goals, said William Yun, the firm’s executive vice-president of multi-asset solutions in New York, at the event.
“If you are looking just at your typical 60-40 equities-fixed income portfolio, you may not be able to achieve your required rates of return,” he warned, noting that such an asset mix would only produce returns of slightly more than 4 per cent.
Thus, he recommended that advisors and investors adopt a “multi-faceted approach” to achieve better returns.
“There are different asset classes, different ways to achieve a return for clients that meet their risk objectives rather than just staying with Canadian equities and Canadian fixed-income,” Mr. Yun said.
That means adding more U.S., international and emerging-markets equities and corporate bonds, and even more alternative assets, such as hedge funds, to the mix.
He notes that the asset mix “depends on each investor, their risk tolerance and time horizon. But, in general, in this low inflationary environment … you may have to consider alternative asset classes.”
As such, advisors and investors might consider other non-traditional assets, such as real estate, to produce superior returns.
Franklin Templeton’s outlook predicts that “the global economic environment will be supportive of risk assets” over the next seven years, which should help those advisors and investors who adopt a more diversified and multi-asset portfolio.
Overall, the firm predicts moderate global growth with low inflation, but more near-term volatility.
The firm remains positive on emerging markets, noting that growth potential should lead to outperformance over developed-market equities and bonds.
In developed markets, Franklin Templeton expects that equities have greater performance potential than bonds.
Specifically, the firm is overweight on U.S. equities, based on the ability of the U.S. central bank to cut interest rates further if required and a resurgent U.S. consumer, who is enjoying higher wages and employment, and a rising net worth.
Mr. Yun noted that U.S. retail sales are “very strong and if you have even a mildly confident consumer that is spending in the U.S. – where consumption is about two-thirds of the economy – that is another positive sign in terms of its economic outlook.”
As for north of the border, Franklin Templeton money managers recommend investors underweight Canadian equities in the coming year, and they hold a neutral approach to Canadian government and investment-grade bonds.
“We have a fairly cautious view on the Canadian economy given some of the cyclical and structural challenges,” said Ian Riach, Toronto-based senior vice-president and portfolio manager, Franklin Templeton multi-asset solutions, at the event.
He pointed to rising manufacturing inventories and declining capital investments and corporate profits, plus a heavily indebted Canadian consumer, who may be running out of borrowing capacity.
It’s estimated that Canadians currently owe $1.75 for every dollar in income that they generate, almost double the 90 cents owed per dollar earned in 1990. By comparison, U.S. consumers have cut their debt since the recession of a decade ago and are in better shape financially.
“With consumer debt at high levels and maybe the negative implications that it can have for banks, and challenges within the resource sectors, the Canadian economy is vulnerable,” Mr. Riach said.
That includes not just the energy industry, but also the mining and forestry industries, which face challenges because of trade disputes and a global slowdown.
He noted that corporate fundamentals in the form of profit margins and earnings per share are “not dire but are weakening,” while there are policy hurdles to foreign investment in the form of perceived high business tax rates and excessive bureaucracy in Canada.
Canadian equities are priced “fairly attractively” compared with those in the U.S. and their long-term averages, but Mr. Riach is not recommending a buying spree, noting that markets can stay undervalued for long periods.
“Despite valuations being very attractive, we think Canadian equities are vulnerable to further disappointment,” he said.
Franklin Templeton’s analysts are also downplaying the possibility of a recession this year, putting the odds at just 20 per cent, stating that it would take an extraordinary shock to the economic system to cause a downturn.
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