While the short term is uncertain, long-term prospects are still positive
By Alfred Lam, CFA
Senior Vice-President and Chief Investment Officer, Multi-Asset Management
The Multi-Asset Management team recently modelled future returns of major asset classes such as Canadian bonds, global bonds, Canadian equity, U.S. equity, international equity and emerging markets equity. The good news is every asset class is expected to earn positive returns. In developed markets, the U.S. ranks poorly as valuations are higher and the cost to hedge the U.S. dollar is rising. We are currently hedging about 60-70% of our U.S. dollar exposure. We have compelling reasons to believe the U.S. dollar will depreciate, so hedging, albeit with a cost, is expected to yield better results than not hedging. The U.S. government is going to run a large deficit even as the economy grows, adding to the already mega-sized debt. Borrowing costs are rising as investors re-evaluate the creditworthiness of the U.S. government.
Since rising rates on larger debt would only mean a larger burden, the U.S. government will need to find a way to offset higher costs; in my opinion, a weaker dollar appears to be the only option. Canada and emerging countries are more attractive on a relative basis. A lot of our readers will probably be surprised to hear about our expectation in Canada given the sentiment is so low. Investing is not about what we want now, it is about what others will want in the future. With compelling valuations and an economy supported by hard-working, educated individuals, Canadian companies are competitive in the global framework.
What we haven’t told you, before you get too excited about the positive future returns, is that:
- Short-term returns can deviate significantly from the long-term average that our study was based on; and
- The time horizon from those returns to be realized is seven to 10 years on equity.
Our risk management strategy is applied to reduce short-term volatility without sacrificing too much of the long-term upside. We believe this is a time not to be overly pessimistic, but also not overly aggressive.