Planit:Historical Returns Update for 2008
From Planipedia
In our 5.01 version of Web Advisor we will be doing an update to the 2008 historical returns data. We use this information to identify long term real rates of return for each asset class, as well as the overall portfolio return for the client’s current and target asset allocation.
This year we’re taking a different approach. In the past, we used 35 years of history to identify the returns for each asset class. The 2008 update will use data going back to 1950, where historical benchmark data exists. Making this change to a longer time period has had the biggest impact on fixed income returns. Another significant factor has been our market results for 2008 which of course had the largest impact on the equity asset classes.
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December 31st 2007 vs. December 31st 2008
The chart below compares historical rates of returns for each asset class at the end of both 2007 and 2008. Note that these returns are based on an assumed forward looking inflation rate of 3%, which is the default Canadian inflation rate on most sites
When we look at this comparison, we see that almost all asset classes experienced return reductions These ranged from as little as .01% to as high as 3.32%. Let’s look at some of the changes in more detail.
Fixed Income – The fixed income asset classes (Cash, Short Term Fixed and Fixed Income) experienced reductions of up to 1.49%.This is mainly the result of using the longer time frame going back to 1950. For some time, our users have been expressing concern that double digit returns from the 1980’s had skewed Fixed Income returns upwards and that those numbers would not be achievable in the future. The longer time period makes the impact of these high returns of the 1980’s less significant.
Canadian Equities – When we look at Canadian Equities, you’ll see that it has had the smallest return reduction of all the asset classes, only .01%. Given that we know that Canadian Equities had a loss of about 33% in 2008, this tells us that this loss has been offset by using a our longer time period going back to 1950.
Canadian Small Cap Equities – This is the asset class that had the largest return reduction, a whopping 3.32%. This reduction is totally attributable to a loss over 50% in 2008. The change to the longer time frame had no impact, either positive or negative, because the data for this asset class only goes back to 1987. U.S Equities – This is the only asset class that has experienced a return increase. Even though the return for 2008 was negative 21.92%, the expanded data period going back to 1950 has offset the impact of the 2008 losses and in fact resulted in a .84% return increase.
U.S. Small Cap Equities – U.S. Small Cap Equities has a reduction of 1.05%. The primary cause of this reduction was the negative performance of 17.94% in 2008. The impact of this loss was not mitigated by the change to a longer time frame because data only goes back 30 years for this asset class.
International Equities – The reduction for International Equities is .88%. Once again the negative return of 26.05% in 2008 is the cause of this reduction. The impact of this loss was somewhat mitigated with the longer time period used for International Equities (39 years).
Real Estate – Real Estate has the second highest return reduction of 1.96%. This was caused by the negative 37.89% return for 2008. The results for 2008 were somewhat mitigated by our change to the 59 year time period. In other words, if we were still using the 35 year history, the negative impact would have been even more significant.
New Target Portfolios
When we see significant changes in the risk and return for the underlying asset classes, as seen above, it means we need to review the target portfolios used in Web Advisor to ensure that they are still efficient. This exercise has resulted in us making some changes to the target portfolios as illustrated below.
The cells that are shaded identify where the weighting into a class changed this year when compared with last year. For example, you’ll see a trend to reduce Canadian Small Cap given its new risk/return profile.
The overall the weighting into Fixed Income vs. Equities has moved up slightly in each of the portfolios. This is an overall move to a slightly more conservative approach.
Security Selection and Preferred Portfolios: If you have created any preferred portfolio’s that you use when doing Security Selection for your clients these may need to be adjusted to recognize the new target portfolio weightings. This will be the case if you have built your preferred portfolios around the asset allocation in the target portfolios.
Portfolio Returns and Standard Deviations
Now let’s look at the impact that the new returns and asset allocation weightings have had on the projected returns and standard deviations for each of the target portfolios.
Here are some of the highlights from the above comparison:
1. Return reduction across the board: When we look at the old portfolio returns vs. the new returns, you’ll see that there’s a reduction across the board. The largest drop is 1.25% and the smallest drop is .99%. This is very much in line with what we have seen in the markets for 2008 and will not be much of a surprise to clients.
You may want to review your assumptions: Many advisors have been using the return reduction feature on the Asset Allocation screen to create more conservative return assumptions when doing planning for their clients. This may have been in anticipation of the lower returns that we are seeing or perhaps to recognize the impact of MER’s on benchmark returns. The key is to give some thought to the reduction factor you have used in the past, to ensure it’s still appropriate in light of these new numbers.
2. Reductions in Conservative Portfolios Returns: You’ll see that the two conservative portfolios have had significant drops even though they are not as exposed to equities. The longer time frame going back to 1950 has had this effect and reduced the skewing of returns caused by the unreasonably high interest returns of the 1980’s.
3. Standard deviations are higher: When we look at the standard deviations for the old portfolios vs. the new, we see that they are all higher. This isn’t too surprising given the results for 2008.
Conclusion
We are providing this analysis so that you are aware of how the 2008 update on the historical returns will affect your client reports. The target portfolios and projected returns for the current and target portfolios (seen in the Investment Policy Statement and other planning documents) will be reduced across the board based on the updated historical returns. You’ll also see a negative impact on the client’s long term planning calculations since lower returns will impact results. This is a good example of the importance and need for regular client reviews to ensure that as planning assumptions change, your strategy is modified to ensure that your client is still able to achieve their life goals.
We hope this information will help you to answer client questions when they see their return projections have changed from their last review.
