The Globe and Mail, Report on Business
Published January 5, 2013

By Tom Bradley

I’m constantly hearing that it’s been a tough few years for money managers. It’s true that the macro-economic situation has brought uncertainty and volatility, and there’s been no such thing as “safe” income. But in one respect, the past couple of years have actually been pretty easy for managers.

Due to a steady diet of bad news, clients have been expecting the worst when they open their account statements and yet, they’ve been pleasantly surprised most quarters. “Wow, I thought I would be down” has been a common refrain. Now I’m generalizing, of course. Some investors did better than “I’m not down” and are ecstatic, while others were less pleased. But there’s no doubt that exceeding client expectations has been easier.

As year-end statements come out in the next few weeks, the trend is likely to continue because 2012 was a good year. In the fixed-income area, there wasn’t much to be gained by owning secure, short-term investments like money market funds and GICs, but investors who took some interest rate and credit risk achieved reasonable returns. The bond market, as measured by the DEX Universe Bond Index, had a return of 3.6 per cent for 2012. Higher yields and minimal defaults meant corporate bonds were two to three percentage points above that.

On the stock side, the year-end rally definitely shined up the final numbers. In Canada, the S&P/TSX composite index was up 7.2 per cent (including dividends), after being down for a good part of the year. The U.S. market beat Canada for the second year in a row with a return of 13.5 per cent (in Canadian dollar terms). The U.S. advance was fuelled by double-digit returns in all but two industry sectors, while our market was held back by a large exposure to energy and materials (both sectors were down for the year).

Canadian individual investors have tended not to own many non-North American stocks, but the MSCI EAFE index was up 15.3 per cent in 2012 (Canadian dollars). Here too, the gains were broadly based across countries and regions, including surprisingly strong results from embattled Europe and no-growth Japan.

As if we needed a reminder, 2012 showed us that market returns don’t often match up with what we’re seeing in the headlines, or how we’re feeling about things. When they do, it’s strictly a fluke. Mr. Market doesn’t read the current news, but rather is looking ahead a year or two. He’s also factoring more into stock prices than just economic data, which are everyone’s focus these days. Companies have their own opportunities and challenges, and stock prices are determined not only by future profits, but by the valuation being placed on those profits.

So while enjoying your statement surprise, it’s important to put 2012 in longer-term context. Over the past five years, which includes the bear market of 2008, balanced portfolios produced annualized returns of between zero and 3 per cent. For 10 years, which is a more useful time frame for long-term investors, the numbers are a healthier 4 to 7 per cent. In other words, $100,000 invested 10 years ago would now be somewhere between $150,000 and $200,000. (Note: As the results start coming in, beware of firms trumpeting their four-year numbers. They’ll look great, but don’t include 2008.)

After an extended period when clients were pleasantly surprised by their returns, I now find myself trying to temper expectations, especially in asset categories that have been driven by declining interest rates and investors’ Sahara-like thirst for yield. Bonds, higher yielding stocks and real estate are all areas where past returns are unlikely to be matched in the future.

I should note that I’m less cautious on the other components of a diversified portfolio where many investors are currently underinvested. I still think it’s appropriate to have a full and diversified allocation to stocks, including some beaten up cyclicals and a healthy exposure to international companies. And I’m quite happy holding a larger than normal cash reserve (10 to 15 per cent) in lieu of bonds.

So as your statements arrive in next few weeks, enjoy the 2012 returns, but keep your long-term expectations in check. I don’t want you to be disappointed when you open your statement five to 10 years from now and see you’ve earned 1 to 3 per cent a year from bonds and 6 to 8 per cent from stocks.