Considering that equities have been in an almost decade-long bull market and bonds have prospered for three decades, Nathan Thooft, senior managing director at Boston-based Manulife Asset Management, expects investment returns looking out five years will be half of what they used to be.
"Most people think that equity returns are 8% to 10% over long periods. In the current environment, though, most of our equity returns are forecast to be between four and six percent," says Thooft, adding that the higher numbers are attached to Europe and emerging markets. Forecasted returns for fixed income are around 1% to 2%.
Thooft is also co-head of Manulife's Portfolio Solutions Group (PSG) and a senior member of the global team of 35 investment professionals that oversees about $140 billion in assets under management for clients in Canada, the United States and Asia. In Canada, their responsibilities include managing four asset-allocation portfolios that were launched in May and currently have about $550 million in assets.
Ranging from conservative to growth in orientation, the fund-of-funds portfolios employ a varying mix of equity and fixed income. Underlying assets consist primarily of a blend of Manulife's own funds and exchanged-traded funds. The construction of the portfolios relies heavily on quantitative and qualitative analysis. "One of the primary starting points for us is to have longer-term, forward-looking return and risk expectations for each of the asset classes," says Thooft, noting that the forward view goes out five years.
About 10% of the portfolios are held in so-called opportunistic positions that reflect where the management team see some of the best values. The execution of these positions varies according to the objective of each portfolio, with equities getting the nod in the growth portfolio, for instance, and corporate credits in the conservative portfolio.
The opportunistic positions offer flexibility to generate higher returns amid a lower-return world. "For example, to further enhance returns in our fixed-income space, we tend to have a much higher weighting to multi-sector, unconstrained types of strategies," says Thooft. "In this environment, where we have very low return expectations, we want to give as much latitude to those underlying managers to deliver as much value as possible, and not be focused on a benchmark-aware approach."
Valuations on the equity side are at best fair if not slightly expensive, especially in the U.S., says Thooft. Yet some Canadian stocks, parts of Europe and emerging markets and Japan still offer decent opportunities, he adds. Indeed, when viewed against fixed income, equities are still favourable compared to what Thooft perceives as the "stretched" valuations in parts of the fixed-income market.
"We do have a slight bias to be more 'risk-on' in our portfolios and that includes a bias to equities and credit exposures. Despite spreads being tighter, we still prefer (corporate) credit over sovereign government bonds," Thooft says. "We've been in a 30-year bond market where bond yields have gone in one direction," While he's not expecting bond yields to go up dramatically, he does expect that yields on sovereign bonds are likely to move higher.
"None of the asset classes are cheap," says Thooft, who leads PSG's asset-class forecasting process and the implementation of asset class and strategy views. "But on a relative basis we do see arguments for why you'd want to own equities over fixed income, on a valuation basis and other fundamentals, such as earnings and growth dynamics."
Currently, some of the main active exposures include a slight overweight to Canadian financials and European equities. "The latter have been an underperformer for the last few years, and people have viewed the region as an extremely slow-growth area with a lot of anti-growth initiatives in place," says Thooft. "But we're seeing an environment that has started to change a bit."
The Eurozone has been growing at close to 2% per annum, thanks to the European Central Bank's accommodative stance, Thooft notes. "You also have very positive PMI (Purchasing Managers Index) levels and other leading economic indicators that are quite strong and likely to stay strong. And it's flowing through in the earnings. People have talked about how good earnings revisions have been in the U.S. and Canada, but if you look at Europe, earnings revisions, and earnings outright, have been very strong," says Thooft. "You have a European environment, at least in the near term, which seems to support a good backdrop for risk assets," he adds, "especially when valuations are not as stretched as they are in the U.S."
Within the balanced portfolio, for example, close to 20% is held in international equity strategies, says Thooft. That represents a material increase in exposure amid improving fundamentals versus 12 months ago. The target mix in the balanced portfolio is 55% equity, 45% fixed income.
Within the conservative portfolio, which has an 80% target for fixed income, most of the opportunistic sleeve is allocated to short-duration corporate bonds and some Canadian bonds. "We have a bias to (corporate) credit," says Thooft.
Each of the portfolios has targeted risk objectives and outcome goals attached to them. "We have to proportionately weight our investment views across the risk spectrum," Thooft says.
In the case of the growth portfolio, says Thooft, there will be larger positions allocated to equity ideas in the opportunistic sleeve. "Those clients will be able to afford the higher risk profiles attached to those equities."
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