Couch Potato Portfolio Returns For 2016

by: Dan Bortolotti

If you believe the media, 2016 was an annus horribilis: some even dubbed it the worst year ever. I think there were a few years during the Great Depression or World War II that might have been worse, but maybe I'm just being a crank.

In any event, it was actually another solid year for investors-the Canadian equity market soared, and despite the surprising Brexit vote and the election of Donald Trump, foreign equity returns where respectable as well, at least in Canadian-dollar terms. Bonds just inched along, but anyone with a diversified index portfolio-whether conservative or aggressive-saw a nice gain last year.

Here's an overview of how the major asset classes performed in 2016:

  • The year started very well for bonds, but interest rates rose late in the year and the broad bond market ended up delivering modest returns. The broad-based FTSE TMX Canada Universe Bond Index finished the year at about 1.7%.
  • After a sharply negative 2015 and several years of lagging the US and international markets, Canadian equities rebounded with a monster year, topping 20% for the first time since 2009.
  • The US bull market just keeps rolling: despite a slow start and a whole lot of doom and gloom around election time, US equities returned close to 12%, though this was reduced to about 9% in Canadian dollar terms.
  • International developed markets (Western Europe, Japan, Australia) saw the only loss of the year, falling about 2% in Canadian dollars. However, emerging markets (China, India, Brazil, and so on) picked them up with a gain of more than 6%.

How the model portfolios stacked up

In tis context, let's see how my model portfolios fared in 2016. Final returns have not yet been reported for the Tangerine Investment Funds, so we'll look at those in a later blog post. For now let's review how the TD e-Series and ETF versions performed. We'll start by looking at the individual fund returns:

TD e-Series Funds

TD Canadian Bond Index - e (TDB909) 1.11%
TD Canadian Index - e (TDB900) 20.63%
TD US Index - e (TDB902) 7.47%
TD International Index - e (TDB911) -2.66%

Vanguard ETFs

Vanguard Canadian Aggregate Bond (VAB) 1.32%
Vanguard FTSE Canada All Cap (VCN) 21.46%
Vanguard FTSE Global All Cap ex Canada (VXC) 4.71%

Now let's combine these returns according to the five different asset mixes in my models, ranging from Conservative (30% stocks, 70% bonds) to Aggressive (90% stocks):

TD e-Series funds

Conservative Cautious Balanced Assertive Aggressive
30% equities 45% equities 60% equities 75% equities 90% equities
3.3% 4.4% 5.5% 6.6% 7.7%

Vanguard ETFs

Conservative Cautious Balanced Assertive Aggressive
30% equities 45% equities 60% equities 75% equities 90% equities
4.0% 5.4% 6.7% 8.1% 9.4%

Teasing out the differences

It's obvious from the above tables that the ETF portfolios significantly outperformed the e-Series versions in 2016. Interestingly, the exact opposite was the case in 2015, when the e-Series portfolios edged out the ETFs despite their higher fees. It turns out the reasons for the diverging performance was similar in both years: it came down to the different index benchmarks these funds use.

Canadian equities. Although Vanguard's VCN and the TD Canadian Index Fund both cover the broad Canadian market, they use different benchmarks: the former tracks the FTSE Canada All Cap Index, while the latter tracks the S&P/TSX Capped Composite.

Although both indexes hold roughly the same number of stocks and use a traditional cap-weighted strategy, they have slightly different rules for selecting and weighting stocks. Over the long term, these differences have evened out, but the year-by-year performance can vary significantly. In 2015 the S&P index edged out its FTSE counterpart, while in 2016 they traded places. These differences are completely random and should be ignored by long-term investors.

Small caps had a big year. The foreign equity exposure in the ETF portfolio comes from Vanguard's VXC, which tracks US and international markets, including large, mid and small-cap companies. By contrast, the TD e-Series funds track only larger US and international companies, with no exposure to small caps.

In 2016, smaller companies outperformed large caps in both the US and international markets, so the broader exposure in VXC gave it a significant boost. While it is may be reasonable to expect a slightly higher long-term return from an index fund that includes small companies, this is not at all consistent.

Emerging markets. Perhaps the biggest difference between the ETF and e-Series portfolios is that the former includes emerging markets: this asset class makes up about 9% to 10% of Vanguard's VXC. There is no e-Series fund tracking emerging markets, so it's absent from the TD model portfolios, which therefore have a higher allocation to international developed markets.

This had a significant impact in 2016, because international developed markets was the worst performer of the year, while emerging markets did very well. As a result, the foreign equity portion of the ETF portfolios got another boost compared with the e-Series. Again, this will vary a lot from year to year: in 2015, emerging markets were the laggards that dragged down the ETF portfolios.

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