“Portfolios” is an ongoing series that discusses various asset-allocation options. In this issue, Investment Executive speaks with Don Fraser, vice president, Connor Clark & Lunn Private Capital Ltd. in Toronto; Pamela Russell, portfolio manager, Goodman Private Wealth Management in Victoria; and Randall Takasaki, vice president,HSBC Securities (Canada) Inc. in Vancouver.



A couple, whose partners are both 65 years old, have $4 million in non-registered assets and $1 million in RRSPs. The couple also own a house worth $1 million with no mortgage.

The husband and wife sold their jointly owned business a year ago and now require $200,000 annual gross income (in today’s dollars), or $125,000 after taxes, until they reach the age of 95. They also want to leave an estate of $5 million, in today’s dollars, to their two children who are self-sufficient.

Both partners qualify for full CPP benefits but neither has a pension. The couple have a low tolerance for risk and are not prepared to take more than a 10% decline in the value of their assets at any given time.

Fraser, Russell and Takasaki all believe the couple’s goals are achievable but, of the three, only Takasaki thinks this will be accomplished easily; his projections show financial assets of $8.1 million in today’s dollars when the couple reach age 95. Russell believes they will be able to leave $5 million in today’s dollars, but only if the real estate is included. Fraser says that, even with the real estate, they may just make the estate goal.

However, Fraser questions their estate goal and says he would discuss it with them. A $5-million estate, in today’s dollars, is huge for self-sufficient children, and he would want to know why the couple would be prepared to spend less on themselves in order to achieve it. (He notes that $5 million in today’s dollars would be more than $12 million in 2036 dollars.)

The difference in opinion among the advisors is mainly a matter of the real-return assumptions used. Takasaki assumes average annual nominal returns of 7.5% (5.5% real). Russell uses 7% (5% real) for the non-registered assets and 5% (3% real) for the RRSP, which is 100% fixed-income.

Fraser’s real return is only 3% because he assumes 3% inflation rather than the 2% the others project. Fraser is also assuming an annual average 5% nominal (2% real) appreciation in the value of the house. If the appreciation were any lower, the couple wouldn’t make their goal unless the return on their financial assets was higher.

Fraser uses 3% real returns with most clients because he wants to make sure they can meet their goals even if equity markets are relatively weak.

In this case, Russell is also erring on the side of caution, using more conservative return assumptions than the 8%-10% return Goodman advisors normally target.

None of the three advisors thinks the couple needs insurance for either medical or estate reasons. They have enough income to cover whatever medical expenses come up because their travel costs would also come down if one or both had serious health problems.

Nor do they need a joint, last-to-die $5-million life insurance policy, the advisors say. The odds are that the couple will be able to leave $5 million in today’s dollars; the premiums they would have to pay on such a policy would lower the income available for travel.

Takasaki estimates that the annual premium on such a policy would be around $85,000 a year. He adds that this insurance could limit the couple’s flexibility. For example, should the couple want to give each child $1 million five years from now, the husband and wife would then only be aiming for a $3 million estate.

Russell recommends a discretionary fee-based account invested in individual securities, for which she would charge 0.95% of assets. She says individual securities are best for clients with a low risk tolerance and are also better for tax- planning purposes. With mutual funds, wraps and pools, you have no control over when capital gains or losses are taken.

Fraser also suggests a discretionary fee-based account, with the assets invested in CC&L pooled funds. The annual fee would be 1.25%.

Takasaki thinks the couple would be better off with a transactional account for the most of their assets because his experience dictates that clients with this much in assets tend to buy and hold. However, he would suggest wraps or pools — which have fees based on the percentage of assets held — for some of the equities. The overall fee on the total portfolio would probably be less than 1%.

@page_break@Fraser has the most conservative asset mix target — 5% cash, 60% bonds and 35% equities. His historical risk/return data suggest that a more aggressive asset mix would not meet the target of no more than a 10% loss in any one-year period. This asset mix is a target; currently, the balanced income pool that the couple would be in is overweighting equities.

Russell suggests 5% cash, 50% fixed-income and 45% equities.

Takasaki recommends an asset allocation of 50% fixed-income and 50% equities.

All three advisors agree that the couple need a certain amount of growth to achieve their desired goals. But Fraser thinks they can’t go higher than 35% in equities and still ensure that the portfolio never drops more than 10%, while Takasaki believes drops of that magnitude can be avoided with 50% equities exposure. Takasaki adds the couple doesn’t need a higher equity exposure because the couple have so much money that they don’t need to take on the additional risk and volatility that would come with it.

Russell says equities have a lot to offer these clients. Preferential tax treatment with capital gains and dividends is important for a portfolio that has the majority of its assets in non-registered securities and high income needs. She also believes a margin of safety is built into equities exposure at Goodman because it is a value investment firm that follows a strict discipline of buying equities at a discount to their intrinsic value.

All three advisors would include foreign equities, generally splitting the holdings 50/50 between U.S. and international. With Canada such a small part of global market capitalization, the couple need foreign exposure but also need to take advantage of the Canadian dividend tax credit, plus they don’t want to take on too much currency risk, says Takasaki.

Takasaki would include emerging markets and global small-caps, but that could take the form of a global mutual fund, wrap or pool invested in these areas.

Neither Fraser nor Russell would specifically target emerging markets or global small-caps, but these could be included in the portfolio.

Takasaki would use a mixture of styles, but with a bias toward value because of the couple’s relatively low risk tolerance.

“You don’t necessarily want a 50/50 mix of growth and value styles because they offset each other over time and so would probably not perform better than an index fund. The idea of a style bias is either to increase or reduce risk,” he says, adding he would shift the tilt from time to time, depending on which style is doing better in the marketplace.

Takasaki also believes sector diversification is very important, and would keep the portfolio in line with a benchmark sector weighting chosen by the clients.

There is also sector and style diversification in the CC&L pools recommended by Fraser. The balanced income fund’s current mix is 7% Canadian equities, managed with a growth at a reasonable price style, and 11.5% managed in a value style. There is also 3.5% small-cap Canadian equities and 11.5% in an income fund that is 35% income trusts.

Russell would have about 10% of the total portfolio in income trusts; Takasaki, 5%. Both advisors say there is still value in good-quality trusts, even after the change in taxation.

Russell is a value investor and would buy shares in a small number of best-of-class businesses and hold them for a long time. A typical balanced portfolio would have 20 to 30 stocks and 10 to 15 bonds.

Goodman doesn’t worry about sector diversification in the equities portion of the portfolio, but seeks to ensure that clients are not overexposed in any one area.

For the bond portion of fixed-income, Takasaki recommends an investment-grade ladder that could go out for as long as 15 years. He wouldn’t suggest real-return bonds.

Meanwhile, Russell prefers to actively manage a client’s bond portfolio. She’s currently focusing on five- to 10-year maturities. She would also include preferred shares, amounting to about 10% of the total portfolio, for their tax advantages, and a small amount of RRBs, which she says are currently attractively priced.

Fraser’s CC&L pool would also be actively managed.

Russell would not include alternative investments because the couple doesn’t need the risk.

Fraser would suggest these investments, saying that they would lower volatility and risk. At CC&L, only about a third of clients initially include alternatives, but another third incorporate them later.

Takasaki would include alternatives because they provide a return that isn’t generally correlated to equity markets. He views them as aggressive growth equities and wouldn’t go higher than 4%-5% of total assets. He would use both hedge funds and one or two single-manager funds. In the latter case, he looks for managers with discipline, consistent returns, good track records in down markets and strategies that make intuitive sense.

None of the advisors thinks the couple will need to change their asset mix simply because they are growing older. The mix may need to change, however, in the event that market conditions, their personal circumstances or their risk tolerance changes. IE