“Portfolios” is an ongoing series that discusses various asset-allocation options. This issue, Investment Executive speaks with Karen Bleasby, senior vice president at
Mackenzie Financial Corp. in Toronto; Don Fraser, vice president at Connor Clark & Lunn Private Capital Ltd. in Toronto; Lynne Triffon, vice president, and Scott Bruce, investment counsellor, at T.E. Financial Consultants Ltd. in Vancouver; and O.J. Tuters, senior client advisor at UBS Securities Canada Inc. in Toronto.



A couple, both partners 50 years old, has $500,000 in RRSPs and $500,000 in non-registered funds. They own a house worth $1 million and have no mortgage.

The couple also has a combined annual income of $400,000, or about $250,000 after taxes; they expect to save $100,000 a year until they both retire. They have four children — ages 10, 13, 16 and 18 — for whom they expect to pay $15,000 a year in today’s dollars for four years of university education each.

The couple travels extensively and they view themselves as citizens of the world. They expect to retire at age 65 and plan to spend four to six months a year in Europe or Asia until they reach 80 years of age. Their goal is a combined annual income of $120,000, including maximum CPP benefits, in 2006 dollars to age 80, then $80,000 for age 81 to 95. They don’t necessarily want to leave an estate outside of the real estate. They have a high tolerance for risk and have bought speculative securities in the past.

The five experts agree that the couple’s goals are achievable, even if income requirements turn out to be somewhat higher than expected because of travel plans. Tuters’ projections suggest they could have $20 million in 2051 dollars at age 95; Bleasby thinks they could have $16 million; and Triffon and Bruce believe they could have $6.7 million.

Only Fraser has the couple running out of money at 95. He has assumed that they stop saving at age 60 — except for RRSP contributions — and withdraw more income each year than planned. He says they could withdraw $140,000 in today’s dollars to age 80 vs the planned $120,000, and $92,000 for age 80 to 95 instead of $80,000.

Fraser’s projections were based on an average annual return on the portfolio of 6%, or 3% in real terms (given his 3% inflation assumption). However, he notes, if real returns in fact average 4%, the clients would have $6.7 million in assets at age 95 — even if they withdraw the higher income he assumed in his base case.

The other advisors have used higher real returns: Bleasby assumes an average of 5.3%; Tuters, 4.7%; and Triffon and Bruce, 4.3%. Bleasby and Tuters assume 2.5% inflation; Triffon and Bruce, 3%.

There are a number of reasons why Tuters’ projections result in the largest pool of assets — $20 million — at age 95. First, the software he uses incorporates volatility, so periodic big gains in good years propel the portfolio to a much higher base than the average return suggests. Second, he would put 20% of the portfolio into alternative investments to minimize the risk of big drops in the value of the portfolio. Third, when the clients turn 80, he would put their assets into an absolute-return pool that targets a return of 6% plus 2.5% inflation, which would provide strong growth in the portfolio during the last 15 years. And fourth, capital gains are deferred when possible, with the value-based investments generally sold only when required for rebalancing.

Bleasby, too, suggests deferring capital gains but, in her case, through the use of Mackenzie capital-class funds in which rebalancing and switches among funds can be done without triggering capital gains, providing the assets remain in the capital-class fund family.

Triffon and Bruce agree that deferring capital gains is attractive. However, you also have to take into account the higher fees and commissions charged by funds that defer capital gains as well as how well those funds perform, Triffon says.

Fraser and Bleasby, like Tuters, also recommend alternative investments, but at much lower weightings of 6% and 2.5%, respectively.

T.E. Financial doesn’t usually include alternative investments, says Bruce, because of transparency and liquidity issues, as well as the high minimum investment required, but would consider them once the couple’s assets reach a significant level if the clients expressed an interest.

@page_break@Tuters’ recommended asset mix is 40% equities, the lowest equity allocation of the group. If, however, you add in the 20% in alternative investments — which have equity-like returns — the figure moves up to 60%. But that is still much lower than the others. Bruce recommends a 75% equities weighting; Bleasby, 85%; and Fraser, 82%, which includes a 6% investment in income trusts and 6% in alternative investments.

Bruce recommends shifting to a 60% equities/40% fixed-income asset mix when the couple reaches 65, at which point the assumed real return drops to 4% a year from 5%.

Although Fraser’s and Bleasby’s projections don’t incorporate a change in asset mix, they agree that a lower equities portion would make sense. Bleasby says the couple might want to consider going to 30% equities when they are over 80. She also suggests that the couple may want to have the equities tilted more to a value style — say, 40%-50% — at that point. She recommends 33% value, 33% growth and 33% growth at a reasonable price for their pre-retirement years.

In Tuters’ case, alternative investments are removed from the asset mix at age 80 because the absolute-return pool is already designed to minimize risk while delivering equity-like returns. The equities component in the pool would be 40%, but the assumed real return jumps to 6% a year from 4%.

The reason this pool — with its much higher projected return — isn’t recommended before age 80 is that, in Tuters’ experience, many investors, especially those with an appetite for risk, want the opportunity to get very big returns in “up” markets, which the defensive stance of this pool precludes.

Bleasby, Fraser and Triffon advise setting up a joint RESP and making the maximum contributions of $4,000 per child. Tuters says the RESP isn’t really needed but it is still a good idea to get the tax break.

In Bleasby’s and Fraser’s projections, RESP contributions are made only until each child reaches age 18, which, Bleasby says, should cover about half of the education costs. Triffon says contributions for all the children can be made until the end of the calendar year in which each child turns 20, although the government grants end the year after the child turns 17 — and she recommends that the couple take full advantage of that. RESP plans can exist for 26 years.

Triffon and Tuters also suggest joint “first to die” term insurance to age 65 to increase the after-tax income of the surviving spouse. Triffon says that if the couple were to take out a policy for $750,000, and one of them dies immediately, the surviving spouse would be able to fund $110,000 of after-tax living expenses to age 95 instead of the $88,000 he or she would get without insurance.

Both Triffon and Tuters say the couple should also have disability insurance to cover the remaining 15 years of their working lives. But they don’t recommend critical illness or long-term care insurance because premium costs are high and the couple has more than enough in assets to cover such expenses should they arise.

To manage the couple’s portfolio, Bleasby suggests a non-discretionary account in Mackenzie’s private client division. The others recommend managed accounts. Bruce says the managed approach is best for a couple with these kinds of career and family demands.

Fees would be 1.5%-1.75% at Mackenzie for a private client with this amount of assets and would decline somewhat as assets rise, says Bleasby. At CC&L, fees would be 1.7%. At UBS they would be 1.4% initially, and 0.6% by the time the clients reach age 90. T.E. Financial’s initial fee of 1.6% would also decline as the portfolio increases.

Bleasby recommends Mackenzie capital-class funds. Bruce and Fraser would use pools, although Bruce says individual securities might be added as the portfolio grows if the clients express a preference for them. Tuters says pools would be used initially, but he would then use individual securities when the portfolio reaches $3 million — although pools would be retained for some asset classes, such as emerging markets. At age 80, the portfolio would go in the absolute-return pool.

All advisors recommend U.S. and global equities to enhance returns and minimize volatility. Tuters suggests that 75% of equities be foreign; Bleasby recommends 67%; Bruce, 60%; and Fraser, 43%.

Tuters says UBS’s experience suggests foreign equities provide less volatility and higher returns; he assumes an average annual return of 7% for U.S. and international equities and only 6% for Canadian stocks.

On the other hand, Fraser thinks 43% foreign equities is sufficient for good geographical diversification and likes the lower currency risk that comes with less global exposure.

Bleasby and Fraser would divide the foreign holdings equally between U.S. and EAFE (Europe, Asia and Far East); Bruce would put 55% of his foreign weighting into EAFE; and Tuters suggests 60% in the U.S. Both Bruce and Tuters have specific allocations for emerging markets, at 5% and 2.5% of the total portfolio, respectively. Bruce is also the only one with a specific provision for U.S. small-cap equities, at 4% of the portfolio. Bleasby and Fraser leave exposure to emerging markets and U.S. small-caps up to the managers of the funds or pools they use.

All the funds and pools used incorporate sector diversification. Style diversification is also included except in Tuters’ case, which sticks with a value style.

Fraser is the only one with a specific provision for income trusts in the Canadian equities weighting. He also has a 7% allocation for Canadian small-caps. The others leave their inclusion up to the investment managers.

Bleasby, Fraser and Bruce would diversify by style, but Tuters would stick to a value approach.

Bleasby, Fraser and Bruce would use funds or pools for the fixed-income, which would include some global bonds. Bruce says there’s increased reinvestment risk and difficulty achieving an adequate level of diversification with a bond ladder. However, Tuters disagrees and recommends a managed bond ladder going out two to six years, depending on UBS’s interest rate expectations. IE