“Portfolios” is an ongoing se-ries 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 Inc. in Toronto; and O.J. Tuters, senior client advisor at UBS Bank (Canada) in Toronto.


A couple, whose partners are both 50 years old, have $500,000 in an RRSP in the wife’s name and $500,000 in non-registered funds in the husband’s name. Neither partner is currently working, although the husband — who was recently laid off from an executive position at a bank — is looking for consulting work.

Starting immediately, he expects to earn $50,000-$75,000 a year in today’s dollars in consulting income in each of the next 10 years. (All figures are today’s dollars unless otherwise specified.)

The husband will receive a pension of $80,000 a year when he turns 55.

The couple has four children, ages 12, 14, 16 and 18. The three younger ones are in private school, which costs $20,000 a year per child, and the 18-year-old is starting university. The couple expect to pay $15,000 a year per child through four years of university.

Once the children are through university in 10 years, at which time the husband and wife will be 60, the couple believe they will need a combined annual before-taxes income of $110,000 — including CPP benefits and OAS — or $76,000 after taxes until they reach age 95.

The couple own their home, which is worth $1 million, and have no mortgage debt. They are conservative investors.

Their situation is a tricky one because they will need to withdraw $340,000 just to pay the children’s education expenses in the next five years.

The couple will also need $35,000 a year to cover the gap between the husband’s $75,000 in annual consulting income and their anticipated $110,000 in living expenses. As a result, they could have little if anything left of their non-registered assets when the husband’s pension kicks in.

Nevertheless, our three experts think it’s doable, although Bleasby is not comfortable with the situation. She thinks it will take an average 8.5% return after fees — or a 6% real return, given her 2.5% inflation assumption — plus deferral of capital gains taxes in order to stretch their assets to age 95.

She would urge the couple to assess their options now. They could cut costs by taking the younger children out of private school. Or they could increase income by having the husband work past the age of 65 or having the wife enter the workforce.

Fraser agrees that the first five years will be difficult, but thinks the couple can make it even using a conservative 6% average or 3% real return. His inflation assumption is 3%, vs 2.5% for Bleasby and Tuters.

Fraser even suggests the couple can withdraw a little more than they’re currently planning. His projections show that after the children finish school, the couple could withdraw $90,000 a year after taxes (vs their planned $76,000) and not run out of assets until age 95.

Tuters’ projections are even more optimistic, showing accumulated financial assets of $3.9 million in 2051 dollars when the couple reach 95 — and that’s with projected average returns of 6%, or 3.5% real, from age 50 to 79, then 5.25% average (2.75% real) thereafter.

The reason for this: the software that Tuters uses incorporates volatility, so periodic big gains in good years propel the portfolio to a much higher base than the average return would suggest.

Tuters would also put 15% of the portfolio into alternative investments until age 80 to minimize the risk of big drops in the value of the portfolio — and he defers capital gains wherever possible.

Tuters suggests the couple could do better if they put their assets into UBS’s absolute-return Dynamic Alpha Fund. If the fund — which is structured to minimize downside risk — meets its target return of 6% plus 2.5% inflation, the couple could end up with $5.7 million in 2051 dollars.

But investors, even conservatives ones, don’t like to forgo the opportunity to earn bigger returns from time to time. And Tuters recognizes that while Dynamic Alpha fund may be the better strategy, investors may prefer investments that offer an opportunity for higher returns.

@page_break@Bleasby recommends their portfolio be invested 80% in equities in order to try to get the 8.5% return she believes the couple will need. She justifies this by assigning a value of $500,000 to the husband’s pension and counts this as fixed-income. Thus, the equities exposure on the couple’s total financial assets is 53%. And that will fall — at least, initially — as they deplete assets to pay the education expenses. A 55% equities/45% fixed-income asset allocation is what Mackenzie recommends for conservative investors with a long-term horizon.

Fraser suggests a conservative strategy for the non-registered assets for the first five years, when the couple will be drawing on those assets for the education expenses. An asset mix of 35% equities/65% fixed-income is aimed at capital preservation. Five years is a short time horizon; one or two bad years in equity markets, combined with the withdrawals, could deplete the non-registered assets quickly.

Once the husband’s pension kicks in, however, Fraser suggests they take a more balanced approach and the non-registered portfolio moves to 55% equities. —the same asset mix as the RRSP throughout.

Both of Tuters’ suggested investment strategies would have 51% equities to age 80, but if the couple choose to go with a traditional conservative strategy, the equities would then sink to 25.5%.

Tuters would include a 15% asset allocation in hedge funds or alternative investments to age 90 with the “conservative” option. But not thereafter, as bonds and cash would make up three-quarters of the portfolio.

Tuters says there’s a big education factor to persuade investors to use alternative investments. Investors need to understand that the risk is low when you use multi-manager, multi-strategy pools in which managers and investments are closely monitored, as is the case with UBS’s pools. There aren’t alternative investments in the Alpha fund as the fund is already structured to minimize downside risk.

Fraser would also use alternative investments, but for a lower asset allocation of the portfolio: 7.5%.

Bleasby would not use them at all because the couple’s portfolio never gets large enough to justify these investments, given the high minimums required for many of these products. Instead, she would use 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. Annual fees would be 1.5%-1.75%.

Fraser would use pools and charge a fee of 1.25% a year.

Tuters would also use pools for the equities and alternative investments, but would build a bond ladder two to six years out for the fixed-income portion. Fees for the “conservative” strategy would be 1.4% to start, but would decline as assets grow, reaching 1% at about age 80. Fees for the Alpha fund would also start at 1.4% and drop to around 1%.

All three advisors would include foreign equities to enhance returns and lower volatility. Bleasby and Tuters feel a lot of foreign exposure is appropriate, but Fraser suggests placing only 35% of the equities outside Canada because he likes the lower currency risk that comes with having 65% of the equities in Canadian investments.

Bleasby would have two-thirds of the equities portion in U.S. and international equities, divided equally.

Tuters would have 72% foreign: half in the U.S., 42% of it in Europe and the Pacific Rim, and 8% in emerging markets.

Funds and pools also facilitate style diversification. Bleasby suggests an equal mix of value, growth and growth at a reasonable price until they reach age 80, at which point the couple may want to tilt the portfolio toward a value style with a 40%-50% allocation in equities.

Fraser leans toward value for this couple, suggesting about 60% of the equities be managed in that style and 40% using GARP. Tuters would also stick with value investing.

Bleasby says the couple can’t afford to invest in RESPs. Both Fraser and Tuters think they should maximize RRSP contributions first because of the deduction against income, but suggest the couple should take advantage of the tax sheltering and government grants that come with RESPs, if they have the cash flow.

Tuters suggests joint “first to die” insurance to at least age 60 and preferably to age 65, as well as disability insurance for the husband for as long as he’s working. Tuters assumes that the husband’s pension plan will have some medical benefits, but even if it doesn’t, he wouldn’t recommend critical care or long-term care insurance because it’s very expensive. IE