It’s always interesting to know what the smart money is doing. And I’m not talking about the investment managers who appear on BNN to “talk their book” — like the guy who runs the precious metals fund and suggests you by precious metals. The smart money are the managers of pension and endowment funds worth billions. They earn their salaries by producing excellent investment results, not by charging high fees while delivering mediocre returns.
Steve from the Think Dividends blog recently suggested I look at creating a portfolio aligned with the asset allocation used by the Ontario Teacher’s Pension Plan, the biggest and one of the most successful pension funds in the country. However, the OTTP’s portfolio is impossible to shadow with ETFs: much of it is private equity and hedge funds. Besides, anyone who invests in the Toronto Maple Leafs can’t be taken seriously. Instead, I looked to the Pension Investment Association of Canada, which compiles data on 130 pension funds.
Before considering how you can use this information to help you design your own portfolio, remember that pension funds are not like individual investors in some important ways. First, they have an infinite investment horizon. The rest of us will eventually retire and die, hopefully in that order. Pension fund managers also have access to investment opportunities that are unavailable to individuals: private equity, hedge funds and risk-management tools such as derivatives. While most institutional funds employ passive strategies — that is, they invest in entire asset classes rather than picking individual securities — they also use active management to try to exceed their benchmarks.
That said, the composite asset allocation of 130 pension funds represents the collected wisdom of managers who handle over $905 billion. Here’s how they invested that staggering sum, as of December 31, 2009:
| Canadian equities | 15.9% |
| US equities | 6.4% |
| EAFE equities | 6.3% |
| Emerging markets equities | 2.3% |
| Global equities | 13.0% |
| Total equity | 43.8% |
| Canadian nominal bonds | 25.6% |
| Real return bonds | 4.7% |
| Mortgages | 0.7% |
| Foreign fixed income | 1.9% |
| Cash and equivalents | 0.1% |
| Total fixed-income | 32.9% |
| Real estate | 9.0% |
| Infrastructure | 3.9% |
| Venture capital/private equity | 6.0% |
| Hedge funds | 2.0% |
| Other assets | 2.4% |
| Total other | 23.3% |
Turns out that only about 10% of these assets fall into exotic categories: the 6% allocated to venture capital and private equity, the 2% to hedge funds, and the 2% lumped together as “other.” The allocations to mortgages and foreign fixed income are too trivial to worry about in a small portfolio, so we’ll just include them with other nominal bonds. It’s impossible to know what countries have the most weight in the “global equities” category, but we’ll divide up that 13% among the US, international developed and emerging markets. When we round off some numbers for simplicity, we can boil down our model pension-plan portfolio and simulate it with these ETFs:
| Asset class | Exchange-traded fund | ||
| Canadian equities | 15% | iShares S&P/TSX Capped Composite (XIC) | |
| US equities | 15% | Vanguard Total Stock Market (VTI) | |
| EAFE equities | 15% | Vanguard Europe Pacific (VEA) | |
| Emerging markets equities | 5% | Vanguard Emerging Markets (VWO) | |
| Real estate | 10% | iShares S&P/TSX Capped REIT (XRE) | |
| Infrastructure | 5% | BMO Global Infrastructure (ZGI) | |
| Canadian nominal bonds | 30% | iShares DEX Universe Bond (XBB) | |
| Real return bonds | 5% | iShares DEX Real Return Bond (XRB) |
The first thing you’ll notice is that this is a very conventional portfolio — if you consider the infrastructure component just a specific type of global equity (which it is), it’s almost identical to Canadian Capitalist’s Sleepy Portfolio. Maybe CC should send his resume to some pension funds and offer his services as an investment manager.
Of course, pension funds are a lot more sophisticated than your average Couch Potato — I’m pretty sure they don’t buy ETFs through BMO InvestorLine. But overall, their strategy comes down to investing in a diversified mix of Canadian and foreign stocks, real estate and bonds. If you’re doing the same with your indexed portfolio, count yourself among the smart money.
The article makes the same mistake as the fund companies that create some of these funds. EAFE and Emerging Markets are overlapping asset classes. As well, infrastructure conmpanies are often found in other sector classes, like energy, for instance. You guys need to get purer about your definitions. The typical breakdown to avoid overlap is:
Region –> Country –> Market Capitalization –> Sector
TJ: Sorry, but you’re wrong about EAFE and emerging markets. The EAFE index includes developed markets only: Western and Northern Europe, Australia, New Zealand, Japan and Singapore.
Emerging markets include Eastern Europe, India, South America, China, Taiwan, Thailand, Malaysia, Philippines and Africa.
Love the post, I think people imagine building a retirement portfolio is so complex to build & maintain when really almost anyone can do it. Start off with the sample portfolio, modify weights over time (no need to even trade, simply investing additional money into the “underweight ETF”). It really is that easy. I will be writing about this in a few days but I think that a retirement account should be simple and boring. If I want to play around and make stock picks, I’ll do it with other non essential accounts…. Nicely written.
Great post Dan! Great to see the emphasis on bonds at ~ 35%. Personally, I would replace XIC with XIU, but what you’ve displayed is a model portfolio anyone can and likely should copy.
Great post Dan.
The thing that I found most interesting about the asset allocation of the Ontario Teachers Pension Plan is that they only have 7% of their portfolio in “traditional” fixed income (XBB). Instead they are more concerned with inflation and have 20% of their portfolio in Real Return Bonds (XRB).
TD: Thanks again for the idea! That’s one of the main reasons I didn’t break down the Ontario Teachers’ Plan: I can’t see recommending that individual investors allocate so little to nominal bonds and so much to real-return bonds. Plus, there’s the whole Toronto Maple Leafs thing. :)
Interesting exercise. I’m thinking that this portfolio would only be for retirees who can handle some volatility since it’s not very conservative.
I’ll second Financial Cents with the XIU recommendation, but that is a minor quibble.
Thanks for this great post. DIY investors can also look at the CPPIB which openly discloses their asset allocation on their website. When comparing my IPS with a pension fund, one thing that comes to mind is investment horizon: whereas I am slowly decreasing my exposure to equities as I approach retirement, pension funds don’t ‘mature’ in the same sense as they are structured to meet expected payouts to pensioners. I suppose these will fluctuate over time but surely a pension fund’s (say the CPPIB’s) asset allocation will change less over the next 20 years than mine. So in my mind it’s not an apples to apples comparison. As for the percentages mentioned above, I guess what surprised me the most was the relatively small allocation to US, Int’l and EM equities. I guess this illustrates the home country bias that envelops many pension funds.
Very interesting Dan – I like the article despite your anti-Leaf stance.
Very interesting article. I would replace the XRB with the Claymore 1 to 5 yrs laddered bonds. “The Leafs sellout every game”. Really good investment!
Michel: Please note that the Claymore funds do not hold real-return bonds, so they’re not a substitute for XRB. You could use them in place of XBB, however.
And, yes, the Leafs are probably a great investment. Like active mutual funds, they underperform every year, but people still want them. :)
I’m confused, how did US Equities get 15% in your asset allocation? US equities is at 6.4% and Global Equities at 13%… The asset allocation for the 130 pension funds seems less invested in US equities than your derived portfolio, or am I missing something?
Marz: I’ve made a bit of a leap here, admittedly. I’m assuming that the 13% allocated to global equity would include at least 5% or 6% in the US, given that the US is over 40% of the global equity market. That gets us up to 11% or 12%. Some of that venture capital, private equity and hedge fund allocation must be in the US as well.
What are your thoughts on BMO’s equal weight ZRE as a substitute for cap weighed iShares XRE? Its tough to justify not unbundling XRE or using ZRE when the top four REIT’s are weighted around 50%. Keep the Maple Laughs jokes going!
Great question. I am planning a future post on the whole idea of equal weighting. To start the discussion, I think it’s important to ask why cap weighting in XRE is a bad thing, even if the top four holdings represent 50%? If those four REITs represent 50% of the sector by cap weight, shouldn’t they have more influence than smaller REITs? Do you equally weight all the sectors in your equity portfolio, investing the same amount in financials as health care? Do you equally weight countries, giving the same weight to the US and, say, Portugal? Something to think about. Will get to that post as soon as possible!
Thanks for the mention! I’m curious as to why there is another “Global Equities” asset class in the OTPP in addition to US, EAFE and Emerging Market Equities. I agree with you that the breakdown of Global Equities is likely in the same proportion as the individual components.
I don’t know if owning the Maple Leafs is such a terrible investment. Here’s Forbes magazine’s look at the Maple Leafs:
Book Value: $470 million
Revenue: $168 million
EBITDA: $79 million
This is an enormously profitable franchise with a lot of pricing power. A lot of sports franchises are vanity investments but Maple Leafs seems to me to be a rare exception. Too bad, it is not publicly traded :)
http://www.forbes.com/lists/2009/31/hockey-values-09_Toronto-Maple-Leafs_312012.html
I knew mentioning the Leafs would open a can of worms!
CC, I’m guessing the “global equities” label is used for investment funds that contain a mix of international securities, and therefore would be hard to separate in such a large data set like this. At least, that’s the way Morningstar uses the term.
Solid post Dan.
Interesting how you said they have an infinite time horizon, although they still need to payout to pensioners. I think it would be similar to a retiree withdrawing 4 percent each year.
Is there any public data on the CPP?
Brian: Pension funds are constantly receiving inflows and constantly making payouts to pensioners. The demographics change, but there are always inflows and always outflows. With a retiree, the inflows stop when he stops working, and the outflows stop when he dies. That’s why a pension fund can maintain a consistent asset allocation, but a retiree should gradually invest more conservatively.
Yes, the CPP info is made public at: http://www.cppib.ca/News_Room/News_Releases/nr_05201001.html
Their current asset allocation is right in line:
Canadian equities 14.5%
Foreign equities 36.2%
Emerging markets 5.0%
Real estate 5.5%
Infrastructure 4.6%
Bonds 28.8%
Inflation-linked bonds 3.4%
Other fixed income 2.0%
I like ZRE over XRE.
The the top 5 holdings of XRE (RioCan, H&R, CREIT, Boardwalk and Calloway) account for 68% of the ETF. By contrast the BMO ETF holds 17 REITs with each name accounting for about 6% of the portfolio.
CPPIB doesn’t pay taxes. That has a significant effect on asset allocation.
Hi Dan:
A great article to provide guidance for retired people. Do you know what the income stream from your couch Potatoe portfolio? Let us say making an investment of $100,000 what will be the annual income stream from your proposed portfolio. If it could be broken down in terms of Dividend, Interest that would be even better. I wish to compare the income stream from this portfolio to what I am currently getting from a mix of stocks, bonds, MMF and ETF’s.
Joshy: Glad you found this helpful. I haven’t calculated the income stream of the portfolio, but this would be fairly easy enough to do using Yahoo Finance or any other service that publishes the yield of these ETFs. It would be in the neighborhood of 3%.
confused by these cp etf portfolios in area of income streams to live off of. What kind of income stream here % wise that one can rely on to live on? does this portfolio completely give away dividend tax credits? any way to modify to help in this area?
I should clarify that this ETF portfolio is not designed as an income-generating portfolio for a retired person. It is designed as a long-term growth investment with an indefinite time horizon.
The portfolio would have a yield of 3%. Any Canadian dividends would would still be eligible for the tax credit if the portfolio is held in a taxable account.
Thanks Dan. The income stream was 2.964% (You were bang on!). I was able to slightly modify the selection of ETF’s (but maintaining the same asset allocation) and come up with an income stream of 3.55%.
I also played around with an asset allocation of 50% fixed income and 50% high dividend paying ETF and was able to get an income stream of 4.92%. There were no Global etf’s in this scenario. This would result in also getting better tax treatment of the income stream (as most of the income would be considered eligible dividends for income tax purposes). If you wish I could share the excel spreadsheet that I have developed for comparing the income streams from various mixes of ETF’s. Please sent me an e-mail.
I believe it is possible to use ETF’s to generate income streams to supplement (or in some cases fully fund) Retirement income. Of course it will very much depend on what you need to live on and how much money you have in your portfolio that can generate the desired income stream. It will also depend on what your objectives are with respect to your portfolio.It is critical to have a clearly defined objective before one embarks on an investment plan.
My objectives are to preserve capital (i.e no drawdown) and to ensure that the income stream from the portfolio will supplement my retirement income and minimize the time I need to spend in maintaining the portfolio. ETF portfolio is probably a great way to achieve that objective.
I have designed ETF portfolios that can generate about 5% income stream before taxes and about 4% after tax income. Therefore if one needs $50,000 after tax income from a purely ETF portfolio, then the portfolio value should be around $1,250,000.
Superb post. I never knew I had so much to learn about passive investing until I started reading your blog.
Awesome post.
Do you see any reason why one would try and mimic this in their personal portfolio over the regular couch potato?
I’m building a portfolio for my retirement (4 -6 years away) that will provide an income stream that eliminates the need to draw against the principal (including bonds @ 35 – 40% of the portfolio). I’m finding it hard to justify the need to look outside of Canadian corporations for good quality dividend stocks. Canadian companies provide international exposure through their business activities. That is, the banks, energy companies, pipeline companies, etc all do business outside of Canada and manage currency risk professionally. Also, with increasing globalization of businesses, there seems to be more and more driect correlation between the performance of various markets around the world. So, as we try to keep things simple in our investments, why not invest in great Canadian multi national companies to provide our income stream?
@Johnny Boy: Diversifying outside Canada isn’t essential. In fact, if your investing goal is primarily to generate income, then there are good reasons to stick to Canadian dividend stocks, which are taxed much more favorably than foreign stocks.
The one potential danger is that Canadian dividend stocks tend to be hugely weighted toward banks, as well as telcos and energy. There are some major economic sectors that are all but absent from Canada (consumer staples, health care, technology). For an investor seeking long-term growth rather than income, Canada is very limiting. I’ve never bought the argument that investing in a multinational is similar to investing directly in emerging markets.
OMERS is now offering its members a program for Additional Voluntary Contributions (AVC). The money can be transferred from an existing RRSP or contributed on a bi-weekly or monthly basis. Active members can contribute up to $3000 depending on their gross salary. Retired members can contribute by transferring from their RRSP between March 1 to April 30 each year. The money is invested in the same vehicles as the pension contributions and the returns are intended to mirror the pension fund returns minus annual investment expenses that have been between 0.4 to 0.64 to date and a fixed annual administration fee currently set at $23. This looks like a good way to invest where the smart money is invested. Can you comment on this program?
If you are going to comment on the pros and cons of the OMERS Additional Voluntary Contributions program then just to make your life simpler here is the website for the AVC progam that OMERS is offering. http://www.omers.ca/pension/Additional_Voluntary_Contributions.aspx
@Darby: Thanks for the comment. I really don’t feel qualified to comment on this specific program, except to say that most people would do well to take full advantage of pension plans at work, which typically deliver better returns than individuals can get on their own.
Thank you for this information. My husband and I just started a canada pension plan. We are excited to be getting ready for retirement. It would be nice to build our own portfolio so we can see the numbers for ourselves. Thanks again!
I agree with Doug’s comment. Pension funds do not pay taxes. Thus, while they might be used as a model to build a retirement portfolio in nontaxable accounts like RRSP, the optimal allocation between Canada and the rest of the world is not so easy if one invest mainly inside taxable accounts.
In his book about professional corporations, Timothy Paziuk recommends business owners to invest only in Canadian equities because of their tax advantage. While this may seem a little extreme, it does seem reasonable to overweight canadian equities if you hold your portfolio inside taxable accounts.
I know this blog post is from 2010 but I’ve only found it now and it’s one of the (many) gems on CCP. It’s bookmarked for future reference!
What is the historic return for your mimicking pension fund portfolio?
@Martin: I did not examine the past performance of this portfolio.
Just curious, if you were tight on registered account space, where would you put specialized ETF like ZGI, in taxable, RRSP, TFSA? I would guess it produces a lot of dividends, but some of it is in Canada and some US.
Thanks again.