Investing through 2024 and beyond with robust portfolios

Craig Maddock

January 17, 2024

Key messages

  • Despite short-term uncertainty, our estimates suggest a moderate growth portfolio has the potential annual return for the next 10 years of 6.2%.1
  • Our strategic asset allocation process builds portfolios that aim for the highest return at a given level of risk while being highly diversified.
  • Our portfolios are strategically built for long-term success and are supplemented with short-term tactical adjustments.

As we kick off the new year, it’s traditionally time to look back at the previous year and provide an outlook for what lies ahead, and we’ll cover that in detail in an upcoming podcast episode. Spoiler alert, inflation, interest rates and short-term results continue to drive the discussion.

While these concerns are valid – after all, we spend the appropriate amount of time considering these factors when making shorter-term tactical adjustments to our clients’ portfolios – it’s important to not lose sight of longer-term considerations because the stories can be quite different.

For example, let’s compare our 12-month and 10-year perspectives.

Near term, all is not well

For the next 12 months, our models, tools and judgement suggest that there is a higher probability of global economic activity slowing. This may lead to recession. The likelihood that companies will face challenges in growing profits or expanding margins has increased. It’s difficult to see why the market would reward companies with higher share prices and ever-expanding price multiples.  

The risk of slowdown is the result of the cumulative monetary policy adjustments (interest rate increases) enacted by central banks to tame inflation. While it seems likely that major central banks are nearing the end of their rate hiking cycles, the impact on the global economy is still very much playing out. The longer higher rates persist, the greater the negative impact on economic activity. Although most investors and analysts expect rate cuts sooner rather than later, these cuts will likely be gradual, so higher borrowing costs might be with us for a while longer yet.  

The wildcard in all of this is employment. So far, companies have not significantly cut personnel in the face of cost pressures. This is in part due to the post pandemic need for workers. As time passes and the glut of demand from reopening wanes, the reduced spending from higher borrowing cost will filter through to company profits, slowing earnings growth and market exuberance. 

It is time for caution and patience, which is why we maintain a slightly defensive posture overall – we are tactically underweight equities relative to fixed income and biased towards longer duration bonds (higher interest rate sensitivity) to capture upside should rates come down.

Longer term, these concerns will likely seem overblown

Through uncertainty and market volatility, we remain firmly anchored in our long-term strategic asset allocation process. As we look out the next 10 years, our forecast starkly contrasts against our shorter-term tactical views. 

Estimated 10-year performance of a moderate growth portfolio (~60% equitites, 40% fixed income)1
  Current Forecast 2023 Forecast 2022 Forecast 2021 Forecast
Annualized potential return 6.2% 6.1% 4.6% 4.6%
Annualized standard deviation 7.3% 7.3% 7.1% 7.2%

Estimated data is not guaranteed and is for illustrative purposes only. Source: Multi-Asset Management, Scotia Global Asset Management

Our analysis suggests that a typical moderate growth portfolio has the potential annual return for the next 10 years of 6.2%, while experiencing 7.3% variation in returns.1 This is little changed from our 10-year forecast from last year and still a notable improvement from prior years.

To build these forecasts, we derive forward looking estimates for over 100 global assets classes (including alternative investments and private assets), common or well-known benchmarks and active strategies (more on this later). We call this our capital market assumptions.  We decompose each asset class into its component parts and consider how they might evolve over the next decade.  

Current 10-Year capital makret assumptions for major benchmarks2
  Annualized potential return Annualized standard deviation
Broad fixed income 4.2% 4.4%
Canadian equities 7.3% 14.7%
U.S. equities 6.5% 14.3%
International equities 6.9% 14.9%
Emerging market equities 8.3% 18.8%

Estimated data is not guaranteed and is for illustrative purposes only. Source: Multi-Asset Management, Scotia Global Asset Management

Why do we do this? In the world of asset management and performance reporting, the disclaimer of past performance not being indicative of future performance is commonplace. It’s simply not enough to look back on historical performance data – returns, risk, correlation – to build portfolios that our clients rely on to help achieve their financial goals.

Incorporating an educated, thoroughly researched and well-thought-out estimate of potential future performance is critically important to achieving investment success for our clients. 

Armed with capital market assumptions, we build robust portfolios

In every portfolio we build, we combine some of the asset classes from our capital market assumptions. Part of our process is to build out portfolios that span the continuum of risk and return. We then identify portfolios that are optimal – the ones that provide the highest potential return for a given level of risk. At the same time, we identify portfolios that are the most diversified – the ones with the lowest correlation of return drivers.

Our process then iterates between the optimal and the most diversified until we get a portfolio that is closest to optimal and is the most diversified – this is what we call a robust portfolio. It is our opinion that this portfolio maximizes the probability of achieving investment success. 

Forecasting active strategies

A common approach to portfolio construction is the linear approach.  In this example, a portfolio might have a 20% target allocation to Canadian equities. Using the linear approach, the manager would simply allocate 20% of the portfolio to an active Canadian equity strategy.    

However, consider that the active Canadian equity strategy is biased towards higher-yielding securities, has a lower weight to cyclical sectors and is lower risk overall than the broader Canadian equity market. This may lead to the expectation that the active strategy will outperform over the long term. 

Armed with this enhanced insight, we can adjust the 20% linear weight and build a portfolio that may better help achieve client goals.

It's an ongoing process.

If our capital market assumptions change materially, we change our portfolios. For example, if our expectations for U.S. equities goes down, we may adjust client portfolios strategically. As another example, if we identify a new asset class that may be able to add value to client portfolios, like private equity, we can determine how best to include it. The key is that we aim to maintain a consistent risk profile over time.

Changes made here will likely have far more impact on longer-term results than our shorter-term tactical adjustments.

Craig Maddock

Craig Maddock, CFP, CFA, CIM, MBA, is Vice President, Senior Portfolio Manager and Head of the Multi-Asset Management Team of Scotia Global Asset Management. He leads the team of portfolio managers and investment analysts responsible for managing the firm’s mutual funds, investment pools and portfolio solutions.