OK, so this doesn’t have much to do with preferred shares. But it is such a basic part of portfolio planning and so little known that I really should give it its own post. I mentioned last year’s version on May 25, 2015.
The Financial Planning Standards Council has announced:
and Institut québécois de planification financière (IQPF) have released updated unified Projection Assumption Guidelines for financial planners across Canada. Developed in 2015 by a committee of actuarial and financial planning professionals and updated annually, the Guidelines aid financial planners in making medium and long-term financial projections that are free from potential biases or predispositions.
The 2016 updates were completed with extensive feedback from financial planners across Canada and financial firms from across industry sectors. Based on feedback, additions incorporated into the 2016 Guidelines include:
- •Rate of return assumption guidelines for foreign developed market equities (including U.S. market and EAFE market equities) and emerging market equities, as well as rate of return assumption guidelines for short-term investments, Canadian fixed income and Canadian equities
- •Margins within which financial planners may deviate from the rate of return assumption guidelines, with explanation for how to apply the margins
- •Additional explanations for the rate of return assumption guidelines referenced in footnotes, as well as in the body of the report
- •Updated life expectancy information
The Projection Assumption Guidelines for 2016 are the following:
Inflation rate: 2.1% Return rates Short term: 3.0% Fixed income: 4.0% Canadian equities: 6.4% Foreign developed market equities: 6.8% Emerging market equities: 7.7% YMPE or MPE growth rate 3.1% Borrowing rate: 5.0% To ensure full transparency and replicability, the Guidelines are drawn from four publicly available data sources: the Canada Pension Plan, Quebec Pension Plan, Willis Towers Watson portfolio managers’ survey, and historical data (based on the DEX 91-day T-bill index S&P/TSX, the DEX Universe Bond™ [Canadian bonds] index, the S&P/TSX [Canadian equities] index, the S&P 500 [U.S. equities] index, the MSCI EAFE [Europe, Australia, Far East] index and the MSCI Emerging Markets index).
“Updates to the Projection Assumption Guidelines ensure that financial planners are equipped with the current information to make financial projections,” says Joan Yudelson, FPSC Vice President of Professional Practice, “allowing them to project their clients’ progress toward meeting their life goals and provide appropriate financial planning advice to address any gaps.”
The 2016 Guidelines are in effect as of June 30, 2016. Full detail on the 2016 unified Projection Assumption Guidelines can be found here.
I must say, a nominal return of 4% for Fixed Income looks very optimistic, given that long Canadas yield 1.65% and long corporates are about 3.7%! The main document states that:
The Guidelines were set by combining assumptions from the following sources (each weighted at 25%):
- assumption used in the most recent QPP actuarial analysis, weighted as follows: 50% of the medium-term assumption (2013 to 2022) and 50% of the long-term assumption (2023 and later)
- assumption used in the most recent CPP actuarial report (2019 and later)
- result of the Willis Towers Watson annual portfolio managers’ survey, weighted as follows: 50% of the medium-term projection (year to year) and 50% of the long-term projection (year to year)
- historic returns over the 50 years ending the previous December 31st (adjusted for inflation) or dating back to inception of the index
The historical component is based on the DEX 91-day T-bill index S&P/TSX, the DEX Universe Bond™ (Canadian bonds) index, the S&P/TSX (Canadian equities) index, the S&P 500 (U.S. equities) index, the MSCI EAFE (Europe, Australia, Far East) index and the MSCI Emerging Markets index.
… and ….
The fixed income assumptions used in the most recent QPP and CPP actuarial reports have been adjusted to account for the opportunity of the QPP and CPP to buy and hold fixed income securities for significantly longer than the typical holding period of individuals. A margin of 0.75% is therefore deducted from the QPP and CPP actuarial assumptions to convert the long-term fixed income assumptions into a more relevant fixed income assumption for individual financial planning.
This does not fill my heart with comfort. Using historical returns as an input for fixed income projections is not an endeavor I would recommend to my friends (it can be justified with equities). Perhaps somebody would like to defend the 4% projection in the comments?
The actual document has material of further interest, including portfolio guidelines:
| Portfolio return assumptions based on asset allocation | |||
| Investor profile: | Conservative | Balanced | Aggressive |
| Short term: | 5% | 5% | 5% |
| Fixed income: | 70% | 45% | 20% |
| Canadian equities: | 25% | 40% | 35% |
| Foreign developed market equities | 0 | 10% | 25% |
| Emerging market equities | 0 | 15% | |
| Gross return before fees | 4.55% | 5.19% | 6.05% |
| Assumed fees | 1.25% | 1.25% | 1.25% |
| Net return after fees | 3.30% | 3.94% | 4.80% |