Episode #90: Update on Expected Returns with Raymond Kerzerho

• INTRODUCTION:

François Doyon La Rochelle:

You’re listening to Capital Topics, episode #90!

This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.

Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.

In this episode, we will discuss expected returns with Raymond Kerzerho, PWL’s Senior Researcher.

Enjoy!

• UPDATE ON EXPECTED RETURNS WITH RAYMOND KERZERHO:

François Doyon La Rochelle:

As I mentioned in my introduction, to help us tackle today’s topic, we have invited Raymond Kerzhéro, PWL’s Senior Researcher.

So, good morning, Ray. It’s great to have you back on the podcast.

Raymond Kerzérho:

Good morning, guys. Glad to be here.

François Doyon La Rochelle:

Good morning, James. How are you today?

James Parkyn:

Very good, Francois, how about you?

François Doyon La Rochelle:

Ray, you have recently published an updated version of your Financial Planning Assumptions for Market Capitalization Weighted Portfolio, but before we dig into the details of the report, can you give our listeners a brief introduction to this report and what how it is used?

Raymond Kerzérho:

Yeah, sure. So, real quickly, we’ve been producing this document for many years, and its fundamental mission has remained the same, so to be more specific.

The report provides projections for a bunch of variables that are critical for investors, such as the long-term projections for inflation, returns and the volatility of asset classes. This data is used by our financial planners at PWL when they prepare retirement projections for our clients.

There’s an important nuance, though. These are projections. As I always remind listeners, these are projections rather than predictions. We recognize that our expected returns estimates are subject to a substantial margin of error.

James Parkyn:
For our listeners, I recommend that they go back to our podcast 79 that we’ve published last year. In that podcast, Ray explained the methodology he uses to calculate the expected return estimates. Ray, could you summarize your report for our listeners?

Raymond Kerzérho:

Of course. So what we do, we combine historical return data with forward-looking estimates. So, it’s really two components we put together to arrive at a single expected return for each asset class. Each approach has its limitations, but by combining the two, we hope that some of their respective weaknesses will offset one another and produce our best estimate for future returns. These projections are designed for a 30-year investment horizon. It’s also important to emphasize that there are projections, not predictions, as I mentioned before.

So yes, there’s really a margin of error here, and over a given period, markets may significantly outperform or underperform these estimates.

François Doyon La Rochelle:

Now that we have covered the methodology Ray, you update your numbers twice a year, you’ve been producing this research for over 10 years. Can you now update us on your latest expected returns estimates, and are there any material changes compared to your more recent reports?

Raymond Kerzérho:

Yes, so, let’s go from the start. So, the first thing we look at is really, inflation. So, our long-term projection is unchanged from last year at 2.5%. We also make a projection for the primary residence, which also is unchanged at 1%. 1% is a real number here, so the inflation is taken out of there. 1%, and we must deduct maintenance and property taxes from that capital appreciation estimate.

Looking at the bond market, we have two estimates for that asset class. We make an estimate for short bonds and one for the bond universe, in Canada:

• Short bonds are up from 3.01% to 3.07%, so up 6 basis points.
• Canadian universe of bonds is up by about the same amount of basis points from 3,53% to 3,58%.
• Canadian equity is down from 7.01% to 6.87%, so it’s down 14 basis points.
• S. equity is down very modestly as well, from 6,48% to 6,44%, minus 4 basis points.
• And where you’ll find the biggest change in our estimates for expected returns is in international equity. Which is down by 24 basis points to 7.04%, basically about a quarter of a percentage point.

Just to finish here, all these expected returns are nominal, they are adjusted for inflation, except, as I mentioned earlier, the one for primary residence. And the last thing I want to mention is that:

• 60-40 balanced portfolio has gone down a little bit in expected return from, 5,76% to 5,73%, so basically down 3 basis points. It’s almost nothing.

One thing that I want to mention, why did international equity have such a decline in expected returns compared to all the rest? So, it’s clear that every equity asset classes has performed very, very well for the last 12 months, ending in June 2026. However, international, and especially emerging markets have returned, very spectacular, almost 50%. I think it’s, like, 49-point-something percent for emerging markets, so that had a significant impact on the expected return.

François Doyon La Rochelle:
Yeah, that’s an amazing return.

Raymond Kerzérho:
So, this is for a market cap weighted portfolio, holding straightforward ETFs. But at PWL, we also invest with factor-tilted strategies Such as those offered by Dimensional Fund Advisors. So factor-tilted, mutual funds to put more emphasis, they invest in the total market, but they put more emphasis on value, small cap, and more profitable firms.

Starting with:

• The fixed income factor-tilted portfolio, we have an expected return of 3.19%, which is, like, 34 basis points lower than our estimate for Canadian bonds that we had for the market cap weighted portfolio.
• The Canadian equity factor tilted portfolio is at 7.42%, which is 55 basis points above the market cap weighted. Equivalent to what we’ve discussed earlier.
• The U.S. equity factor tilted portfolio is at 7.07%, which is 63 basis points above the market cap weighted portfolio.
• The international equity portfolio, which includes developed and emerging markets, with a factor tilt, it’s at 7.54%. And it’s 50 basis points above a market cap weighted portfolio.
• Now, to close on this section, the 60-40 portfolio factor tilted portfolio has an expected return of 5.95%, which is 22 basis points above our estimate for a market cap weighted portfolio.

James Parkyn:

Ray, you highlight that the expected return for a 60/40 balanced portfolio is 5.95% before fees but including product and management expense ratios.  There is a lot of debate around this classic 60/40 portfolio because the expected returns on bonds even at a higher 3.58% generates a negative return in a taxable account when you factor out inflation and taxes.

Add to this, when you look at how well equities have performed over the last 20 years despite major bear markets, equities have generated compound returns well above the report’s expected returns. Ray, can you comment on this please?

Raymond Kerzérho:

Yeah, it’s always a problem with investing. In fact, investing inevitably involves a great deal of uncertainty. The fact that equity have outperformed their expected returns over the past 20 years does not mean that we should simply extrapolate those returns in the future. Expected returns are not predictions of what will happen. They are our best estimate based on the information available today.

We also know with certainty, so we’ve discussed uncertainty before, but there’s an element of certainty. We’re certain that severe bear markets will occasionally occur. Fortunately, these are relatively rare. However, they are an unavoidable part of investing.

This is where bonds play an important role. Even when their expected returns are modest, high-quality bonds can help cushion portfolio losses when equity markets plunge. That cushioning effect can be extremely valuable. It can give investors the confidence to stay invested through the difficult periods, rather than selling equities after a major decline. In other words, the role of bonds is not simply to maximize expected returns. They also help make the overall portfolio more resilient and help investors stay the course when doing so is most difficult.

François Doyon La Rochelle:

Now Ray, similar to last year, expected returns on Canadian and international equities are higher than for the U.S. Can you explain why?

Raymond Kerzérho:

Certainly. As I mentioned earlier, we estimate expected returns by combining historical return data with forward-looking valuation measures.

For the forward-looking component, we use the Shiller price-to-earnings ratio.

At the moment, U.S. equities trade at a higher valuation than Canadian and international equities.

In other words, investors are paying more for each dollar of earnings generated by U.S. companies. All else being equal, the more investors pay for a given level of earnings today, the lower the return they can expect going forward. That is why our expected returns are currently higher for Canadian and international equities than for U.S. equities. This does not mean that we expect the U.S. market to underperform every year, or even over every period. Rather, it reflects the fact that starting valuations are an important determinant of long-term expected returns.

James Parkyn:

Ray, last year you did a comparison of other major investment firms that actually also produce what their expected returns are. What do you have to say about this this year?

Raymond Kerzérho:

That’s an interesting question.

Since we project an expected return of less than 6% for a balanced 60-40 portfolio. It might be tempting to conclude that our estimates are overly conservative, but when we compare our projections with those of other major firms, such as BlackRock, Vanguard, and AQR, we actually find the opposite. Our estimates are more optimistic than those of these large investment firms by at least half a percentage point. So, while a sub-6% expected return may seem low in absolute terms, it is relatively optimistic compared to the projections published by many of the major investment firms.

François Doyon La Rochelle:

Now let’s review how Actual Market Returns over the last ten and twenty years compared to the Expected Returns Projections for Globally diversified portfolios.  We will refer to the PWL Market Statistics Report and the PDL Model Portfolio Report.   All reports are as of June 30, 2026.  Ok, so James let’s get right into it.

James Parkyn:

Well Francois, as our regular listeners know, we produce the results of our Model Portfolios for a range of asset mixes allocated between stocks and bonds.  This table of results shows performance over 1, 3, 5, 10 and 20 years. This is useful to compare actual portfolio results.  Today, I will compare the performance results for the last 10- and 20-years.

François Doyon La Rochelle:

James, what would you like to highlight for our Listeners?

James Parkyn:

Well, first of all, the last 10 years, 20 years François, compound returns have been extraordinary. For instance, and I’m going to highlight the returns for the most common allocations for our clients, so please keep in mind these returns are pre-PWL fees, but include the cost of the investment products. Let’s start with:

• The classic balanced, 60% stocks, 40% bonds. The 10-year return was 8.45%, 20 years was 7.12%, and the current expected return for this allocation is 5.95%. So again, a big differential.
• If you go more aggressive to 70% stocks and 30% bonds, the last 10 years were 9.62% and 7.79% over 20 years, and the 2026 expected return is 6.35%.
• The 80% stock portfolio is 10.78%, and the 20% bonds is 8.46%. Again, the expected return in 2026 is 6.73%.

Across the board, the portfolios over 10 and 20 years have done much better than, you know, what we’re currently forecasting for the future.

Raymond Kerzérho:

Yeah, I think, really using the past 10 or 20 years as a primary basis for setting long-term return expectations would be a mistake. Those periods have been very strong, but they represent only a small portion of investment history. Our estimates are based on approximately 125 years of historical data, rather than on the most recent decade or two. And even then, we make downward adjustments for certain factors that contributed to the exceptional returns of recent decades but are unlikely to be repeated to the same extent in the future. The key point is that strong historical returns do not necessarily imply equally strong future returns. For long-term planning, we believe it is more prudent to look at a much longer history and to consider the valuation and economic conditions that investors face today.

François Doyon La Rochelle:

James, these are the compound annual returns, what does that mean for capital accumulation?

James Parkyn:

Well, again, for our listeners, Francois, that’s a great question. The easiest way to explain it is if you invest a dollar today at these compound rates, what would it represent after 10 or 20 years? So, again, I’m going to illustrate for our listeners:

• The balanced 60-40 portfolio after 10 years is $2.25, so if you had $100,000, it would be $225,000. After 20 years, you just have slightly less than $4, that is $3.96, so $100,000 would have become $396,000.
• Again, if you increase the equity allocation because the returns were higher, you know, for 70-30, you’d get $2.51, and for2 0 years, $4.48.
• And then, even more aggressive, 80% stocks, 20% bonds, you’d get $2.78, or $278,000 after 10 years on $100,000 invested. For 20 years its spectacular, 5 times at $5.07, so you’d have over half a million dollars.

Again, that’s a globally diversified portfolio. That’s not making single individual stock bets where you hit it out of the park and get lucky with a mag stock here.

Raymond Kerzérho:

Yes James, but these are past returns. We should be grateful for the great returns, especially those who were invested for all that time. However, looking forward, I think a reasonable dollar estimate, for example, for, over 10 years for the 60-40 portfolio, would be probably 20% lower. So, $1.75 instead of $2.25. And a longer estimate would be at an even bigger discount. So, once again, always the same, problem or danger to a project, the recent past and the future.

François Doyon La Rochelle:

James, what can we learn from these results?

James Parkyn:

Francois, there are many lessons to take away.  I will share four main lessons:

My first lesson is to stick with your plan: staying on course gives you the best long-term results. We have made this point many times in our podcast.  These performance numbers back that up. Despite going through many capital markets crises – think the 2008-2009 Global financial crisis where the global banking system was in peril, the pandemic in 2020 and the resurgence of high inflation in 2022 – stocks generated returns well above long term averages and significantly stronger that Ray’s latest projected Expected Returns.

François Doyon La Rochelle:

As you stated earlier the actual returns for a 60% stocks / 40% bonds portfolio was 8.45% compound over 10 years and 7.12% over 20 years.  This is 2.5% compound extra return every year over 10 years or 1.17% over 20 years.   This means an investor who stayed the course would have accumulated about 25% more capital compared to the 5.95 % we project currently.

James Parkyn:

This can be explained because actual returns on Stocks were much higher than their 2016 Expected Returns – For example, the actual performance of the All-Country World Index was 14.3% in Canadian dollars for the last 10 years, which is 2 times the 2016 expected return of 7%.

François Doyon La Rochelle:

What is your second lesson James?

James Parkyn:

My second lesson is that Actual returns on Bonds were below 2016 expected returns, 3.3% versus 1.7% realized over the past 10 years have been low In Canada 1.71% for the total market. Inflation was 2.79% and therefore Bonds generated a negative return even before factoring in taxes.

François Doyon La Rochelle:

The same goes for the Current expected return for Bonds of 3.19% when you remove both taxes and inflation you end up with a negative return.  Investors really need to think about the long-term impact of a high allocation to the safe bucket.

What is your Third lesson James?

James Parkyn:

Setting a long-term allocation with a higher allocation to stocks generated much better long-term returns.  When we compare the results of a 60% stocks / 40% bonds portfolio which generated an 8.45% compound over 10 years, the 70/30 portfolio generated 9.62% or 1.17% per year better.

François Doyon La Rochelle:

With that portfolio you would have accumulated 11.6% more capital.  With an 80/20 portfolio you would have generated 23.6% more capital.  This is a big differential.  Of course you don’t get that upside without the downside risk.

James Parkyn:

I agree with you Francois, now for my final lesson:

“Know your risk”:  after a decade of excellent returns on Stocks, Investors need to make sure their portfolios are consistent with their plan, their objectives their risk tolerance and risk capacity.

François Doyon La Rochelle:

James, there was an interesting article in the WSJ on July 7 written by Robert Pozen former head of Fidelity Investments titled “You’re probably overinvested in Bonds”.  He argues in favor of a portfolio composed of 90% Stocks and 10% in money market funds.  To me Pozen’s main arguments are heavily based on the market performances of asset classes in the last 20 years.

James Parkyn:

I agree.

Finally, I remind our Listeners that our current Portfolio Performance results are measured as at June 30th, 2026, which has been an extraordinary period for stocks and a comparatively dismal period for Bonds especially in the last 10 years.  The risk is we may fall into a data mining trap.

Ben Carlson also wrote a blog about this WSJ article and he makes the following points: “For investors still putting money into the market on a regular basis, lengthy drawdowns are an opportunity, not a risk. You get to buy stocks at lower prices.  You have a much smaller margin of safety in retirement.  There is no more income from a job to buy stock when they’re on sale.  You don’t have nearly as much time to wait out a painful bear market.”

François Doyon La Rochelle:

Pozen also writes that “rising life expectancies expands an investors time horizon.” To me this is where a skilled advisor can really add value helping clients make the right long term asset allocation.

Overall, James, I believe that what you’re saying is that many investors should perhaps consider a higher allocation to stocks for their long-term asset allocation given the low expected returns of bonds. Is that correct?

James Parkyn:

Yes Francois, but I’m not proposing this in a market timing context but rather in the context of a long-term strategic decision where investors allocation reflects their risk tolerance and their risk capacity.

François Doyon La Rochelle:

I agree James and as I said in the conclusion of our most recent podcast on the mid-year market review these decisions are not about market timing and predicting what comes next, it’s about building a portfolio that is right for you and constantly bringing it back to your long term asset mix when it deviates because of market movements. Remember, rebalancing your portfolio keeps risks in check, reinforces discipline, and helps you stay invested through whatever surprises markets will throw at you.

James Parkyn:

And Francois, I would add as a final point for our listeners, our usual mantra: make a plan, be globally diversified, stay disciplined in difficult markets, rebalance but stick to your plan.

• CONCLUSION

François Doyon La Rochelle:

Thank you, Ray for our participation today, as usual this was very interesting, and I hope our listeners have found it interesting as well.

Raymond Kerzérho:

My pleasure, François.

François Doyon La Rochelle:

Thank you James for your contribution again today.

James Parkyn:

You are welcome, Francois.

François Doyon La Rochelle:

That’s it for episode #90 of Capital Topics!

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