BMO Long-Term Capital Market Assumptions€¦ · BMO Global Asset Management. She also contributes...

BMO Long-Term Capital Market Assumptions

Prepared by:

Yung-Yu Ma, Ph.D.Chief Investment StrategistBMO Wealth Management

Irina Pacheco, CFAQuantitative Strategist and Portfolio Manager — Multi Assets SolutionsBMO Global Asset Management

BMO Global Asset Management 2020

Table of contents

Foreword �� 1

Overview �� 2-3

10-year Capital Market Assumptions — broad asset classes �� 4

Risk and return trade-off — broad asset classes �� 5

10-year Capital Market Assumptions — U�S� ��6

Risk and return trade-off — U�S� �� 7-8

10-year Capital Market Assumptions — Canada ��9

Risk and return trade-off — Canada �� 10-11

Disclosures �� 12

1 1

Yung-Yu Ma, Ph.D.Yung-Yu Ma is the Chief Investment Strategist with BMO Wealth Management.As Chief Investment Strategist, Yung is responsible for performing macroeconomic analysis, valuation modeling, and market analysis across asset classes to guide strategic and tactical asset allocations for client portfolios.Prior to joining BMO Wealth Management, Yung was a finance professor at Lehigh University, where he taught courses in fixed income, equities and derivatives. His academic studies have been cited in the Wall Street Journal, in leading finance journals, top law journals, the Handbook of High Frequency Trading, and in the Oxford Handbook of Corporate Governance. During his tenure at Lehigh, he was awarded the Staub Outstanding Teacher Award, awarded to one faculty member by a vote of faculty and students. Prior to his academic career, Yung worked for a global consulting firm performing financial and market analysis for global companies with operations in Hong Kong, Taiwan and Mainland China. Later, he oversaw the operations at a Fortune 500 subsidiary in Taipei and Mainland China. Mr. Ma earned his Ph.D. in Finance at the University of Utah and his B.A. in Economics and Political Science, magna cum laude, at Williams College. Yung lives in Portland, Oregon with his wife and two children. He is a basketball fan and enjoys cheering on his son’s teams.

Irina Pacheco, CFAIrina provides quantitative analysis that supports the capital markets outlook, asset allocation strategies, LDI strategies and defined contribution investing at BMO Global Asset Management. She also contributes to the company’s financial markets publications, develops analysis for new products and tests market hypotheses.She joined the company in 2006 as a quantitative fixed income analyst. Irina began her investment experience in 2004 as a senior financial analyst for Allstate Investments. She began her working career in 1998, when she joined LaSalle Bank/ABN AMRO as a senior relationship banker.Irina holds an M.B.A. and a B.S. in finance from DePaul University. Before completing her studies in finance in the U.S., she studied computer science for business, with a focus on computational finance, at Romanian-American University in Bucharest. She is also a CFA® charterholder and a member of the CFA® Institute and the CFA® Society of Chicago.

Foreword

BMO Global Asset Management seeks to provide investment solutions that achieve clients’ goals with refreshing clarity� This means offering intuitive products and services supported by rigorous analysis by our investment professionals, whose expertise underpins the value we bring to clients� Data may be impersonal, but insight is not�

The following paper outlines our Capital Market Assumptions (CMAs) over a 10-year time horizon. Our strategists update the CMAs annually using proprietary models along with input from our global team of investment professionals.

By providing the rationale for our strategic asset allocation across equities, fixed income and alternatives, CMAs support BMO Global Asset Management’s overall approach to multi-asset investment. We use these assumptions to offer a variety of portfolio construction options to clients, enabling them to better understand risk/return expectations and enabling us to tailor solutions to more refined objectives.

In addition to traditional mean-variance optimization, the team uses other modern techniques such as mean/conditional-value-

at-risk (mean-CVaR) optimization to evaluate the effects of allocation constraints on expected returns and risks. To build a realistic range of potential outcomes, our team uses the Monte Carlo methodology to generate thousands of return simulations for each asset class. Furthermore, they expand the analysis to capture the effects of different correlation regimes on asset allocation outcomes and to evaluate each allocation’s downside risk exposure.

Our CMAs offer a global satellite view of the investing environment. Whether investors are seeking income, capital appreciation or the ability to meet liabilities or spending targets, our investment professionals use this perspective to help clients visualize a roadmap to their goals.

2

Overview

Our long-term economic view

The coronavirus pandemic has led to recession, collapsing earnings expectations, falling inflation and interest rates, mass unemployment, unprecedented fiscal stimulus, enormous budget deficits, and aggressively stimulative monetary policy� Amid the day-to-day fog of market gyrations, long-term capital market assumptions and their underlying inputs are as important as ever to serve as a beacon for where we expect to land and what could change that trajectory� It is also worthwhile to remember that equities in particular are very long duration assets and even a sharp, multi-year decline in earnings may not have an overwhelming effect on long-term expected returns�

We expect the sharpest declines from the global downturn to rebound by 2023, but persistent and longer lasting economic impacts to remain due to the prior years’ output gap, still high unemployment, ongoing geopolitical tensions, and supply chain restructuring. These longer-term impacts include lower expected growth, lower expected interest rates, lower inflation, and various other considerations. For the large and more developed economies of the U.S., Europe, China, Japan, etc., we do not believe that high debt levels pose an imminent threat over the forecast horizon. Additionally, while we are not making explicit medical predictions related to the pandemic, there is an undeniable implicit assumption that immediate effects on economic activity reduce over the next two years and are largely gone by 2023.

Our prior years’ expectations of flattening yield curves and low interest rates have largely played out. In the coming years, we expect a gradual rise in interest rates to levels that are far below long-term nominal averages. Long-term equilibrium rates of interest, in our view, have again shifted downward primarily due to a reduction in inflation expectations. As before, the expected equilibrium real rate of interest remains just above zero, but this level will take a number of years to reach.

For fixed income, the expected returns take into account both these lower equilibrium interest rate levels and also the current interest rates that have generally declined amid the current global downturn. The net effect for most of fixed income is a reduction in forward-looking expected returns. Equities have similar offsetting considerations — lower growth but a lower discount rate and lower starting point due to recent equity market declines — but the net effect in most cases is slightly higher expected returns. Our model-driven expected equity risk premium remains unchanged, but on a medium-term basis, we believe that compression of this premium is a possibility. Such equity risk premium compression represents an upside risk to our expected equity returns over the forecast horizon. One downside risk is a reduction in corporate profit margins that could come in the form of higher corporate taxes or other government policies, but we do not believe that economic forces alone will drive down corporate profit margins to levels that prevailed in prior decades.

Over the long run, markets are assumed to move toward equilibrium where the risk-reward mechanism generally places global assets on an imaginary efficient frontier line. We conclude this economic overview by reiterating the same sentence that concluded our late-2019 overview: “That sanguine long-term path is, as usual, fraught with bumps and cycles, and even sometimes extremes.”

2

3Source: Bloomberg, BMO Global Asset Management, BMO Wealth Management

1 The Laubach-Williams model measures highly persistent movements in the natural rate of interest (or real rate). Source: “Measuring the Natural Rate of Interest,” by Thomas Laubach and John C. Williams, published in the Review of Economics and Statistics, November 2003. Canadian real rate expectations calculated using linear regression on the historical real rates of the two countries, applying the regression coefficients to derive the expected Canadian dollar. All information based on data provided by BMO Global Asset Management Canada.


A 10-year time horizon reduces the volatility around the expected outcome that would prevail with shorter horizons.

As returns are more volatile during shorter periods than they are over longer periods, shorter-term estimates are unsuitable for strategic asset allocation decisions.

Conversely, a multi-decade time horizon would not accurately capture potential structural changes in financial markets. In addition, the majority of our peers produce capital markets assumptions for a 10-year horizon.

Inflation expectation is based on median long-term break-even U.S. inflation over the past 90 days: • U.S. = 1.15%• Canada = 1.15%

Real rate expectations: • U.S. = 0.3%, informed by the Laubach-Williams model1

• Canada = 0.6%, based on historical differential vs. U.S.

Equilibrium short-term rates: • The 3-month government yield at the end of a 10-year horizon will equal inflation plus the real rate

Why a 10-year time horizon?

Key assumptions

The development of BMO Capital Market Assumptions is a rigorous, quantitatively driven process with a robust fundamental overlay�

The quantitative model framework

The starting point of current Treasury yields is the major factor in expected returns remaining generally below the historical levels of the past 20 to 30 years.

Capital market assumptions for fixed income assets are the result of a straightforward bond pricing methodology, where ending yields for government bonds of various maturities and the yield changes from current levels are used to derive the impact on performance. The compensation for carrying credit risk is expected to be an average of the current credit spread level and the median level observed over the past 15 years.

Capital market assumptions for equities are based on a discounted payout model incorporating both dividends and share repurchases. The model incorporates both near-term and long-term growth assumptions, and an equity risk premium that is both historically grounded and forward-looking. The interest rate assumptions embedded in the equity valuation model are derived from the fixed income model, thereby linking the models for internal consistency.

Outside of equities and fixed income, other models are specialized and often factor-based.

1 If historical data is shorter than specified, the statistics are calcultated using the longest available historical performance.

Source: Bloomberg, BMO Global Asset Management, BMO Wealth Management 4

10-year Capital Market AssumptionsBroad asset classes

10-year estimates (%)Historical performance (%)

(as of May 31, 2020)1

Asset classCompound

returnAverage return

Standard deviation

20-year compound

return

20-year standard deviation

10-year compound

return

10-year standard deviation Representative index

U.S. Cash 0.80 0.80 0.65 1.68 0.54 0.64 0.25 ICE BofAML US 3-Month Treasury Bill Index (G0O1)

U.S. Core Investment Grade Bonds 1.50 1.55 3.45 5.21 3.60 3.92 3.07 Bloomberg Barclays U.S. Aggregate Index

U.S. High Yield Corporate Bonds 5.45 5.95 10.55 7.06 10.20 6.71 7.45 Bloomberg Barclays U.S. Corporate High Yield Index

Emerging Markets Corporate Bonds 5.00 5.35 8.90 NA NA 6.11 6.95 JPM CEMBI Broad Diversified Corporate EM Index

U.S. Large Cap Equity (Russell 1000®) 7.05 8.50 18.00 6.12 16.38 13.07 15.72 Russell 1000® Index

U.S. Low Volatility Equity 7.05 7.75 13.65 6.30 12.40 13.14 11.84 S&P 500® Low Volatility Index

U.S. Small Cap Equity 7.60 9.80 22.10 6.93 21.76 9.23 20.86 Russell 2000® Index

International Developed Equity 7.15 8.65 18.25 3.48 17.49 5.86 16.08 MSCI EAFE® Index

Emerging Markets Equity 7.55 10.05 23.55 6.69 23.78 2.83 18.60 MSCI Emerging Markets Index

U.S. Private Equity 10.00 11.25 16.50 NA NA 10.80 15.00 Cambridge Associates PE Index (50/50 VC and LBO)

Broad assets | 10-year forward estimates vs. historical performance

Expected compound return (%)

Risk (standard deviation) (%)

10-year estimates

Last 10 years

Last 20 years

Trend line (estimates)

Trend line (last 10 years)

Trend line (last 20 years)

0 5 10 15 20 25-7.5

-5.0

-2.5

0.0

2.5

5.0

7.5

10.0

12.5

15.0

17.5

The next ten years will be characterized by generally lower returns, however, risks will remain comparable to historical experience


Risk and return trade-off Broad asset classes

Overall portfolio risk is a combination of risk metrics (i�e�, standard deviation, liquidity risk, excess tail risk) and it is important that they all be taken into consideration when making allocation decisions�

The expected returns and risks, as measured by standard deviation, for various asset classes align reasonably well with a concave function that associates higher expected return with higher risk, but with diminishing additional returns at greater risk levels.

It is important to note, however, that standard deviation as a risk measure does not fully capture the overall portfolio risk or other risk dimensions such as liquidity risk and excess tail risk.

These multiple risks will be present across asset classes to varying degrees.

To the extent that volatility risk does correlate with overall portfolio risk and other risks, the accompanying graphs point an asset class’ risk and return relative to that of other asset classes.

For example, while U.S. Private Equity plots well above the fitted risk curve, its overall risk which captures liquidity and excess tail risk, is not reflected on this two-dimensional graph. Thus, U.S. Private Equity may appear too attractive on a relative basis versus all other assets if only one aspect of its total risk is being considered.

Broad assets | Expected compound returns vs. risks

Expected compound return (%) Asset class [Compound return % | Risk %]


● U.S. Cash [ 0.80% | 0.65% ]

● U.S. Core Investment Grade Bonds [ 1.50% | 3.45% ]

● U.S. High Yield Corporate Bonds [ 5.45% | 10.55% ]

● Emerging Markets Corporate Bonds [ 5.00% | 8.90% ]

● U.S. Large Cap Equity (Russell 1000®) [ 7.05% | 18.00% ]

● U.S. Low Volatility Equity [ 7.05% | 13.65% ]

● U.S. Small Cap Equity [ 7.60% | 22.10% ]

● International Developed Equity [ 7.15% | 18.25% ]

● Emerging Markets Equity [ 7.55% | 23.55% ]

● U.S. Private Equity [ 10.00% | 16.50% ]

— Trend line

0 5 10 15 20 25-2

0

2

4

6

8

10

12

10-year Capital Market AssumptionsAsset class detail: U�S�

6

1 If historical data is shorter than specified, the statistics are calcultated using the longest available historical performance.

Source: Bloomberg, BMO Global Asset Management, BMO Wealth Management


(as of May 31, 2020)1

Asset classCompound


Standard deviation

20-year compound

return


10-year compound

return


EQUI

TIES

U.S. Equity 7.10 8.60 18.20 6.19 16.62 12.79 15.99 Russel 3000 IndexU.S. Large Cap Equity (Russell 1000®) 7.05 8.50 18.00 6.12 16.38 13.07 15.72 Russell 1000® IndexU.S. Large Cap Equity (S&P 500®) 7.05 8.45 17.65 5.94 16.02 13.14 15.38 S&P 500® IndexU.S. Low Volatility Equity 7.05 7.75 13.65 6.30 12.40 13.14 11.84 S&P 500® Low Volatility IndexU.S. Mid Cap Equity 7.40 9.40 20.95 8.26 19.03 11.42 17.78 Russell Mid Cap IndexU.S. Small Cap Equity 7.60 9.80 22.10 6.93 21.76 9.23 20.86 Russell 2000® IndexU.S. Small/Mid Cap Equity 7.45 9.35 20.55 8.13 20.16 10.32 19.74 Russell 2500 IndexU.S. Micro Cap Equity 7.60 10.05 23.40 4.87 22.49 8.33 21.91 Russell Micro Cap IndexGlobal Equity 7.05 8.45 17.65 4.97 16.72 9.11 15.43 MSCI ACWI IndexGlobal Tax-Managed Equity 7.10 8.65 17.65 4.97 16.72 9.11 15.43 MSCI ACWI IndexGlobal Low Volatility Equity 7.05 7.55 11.35 6.29 11.27 9.69 10.56 MSCI ACWI IndexInternational Developed Equity 7.15 8.65 18.25 3.48 17.49 5.86 16.08 MSCI EAFE® IndexInternational (ex US) Small Cap Equity 7.45 9.40 20.90 7.33 19.90 8.19 17.62 MSCI EAFE® Small Cap IndexEmerging Markets Equity 7.55 10.05 23.55 6.69 23.78 2.83 18.60 MSCI Emerging Markets Index

FIXED

INCO

ME

U.S. Cash 0.80 0.80 0.65 1.68 0.54 0.64 0.25 ICE BofAML US 3-Month Treasury Bill Index (G0O1)10-year U.S. Treasury Note 0.50 0.75 7.35 5.56 7.66 4.81 6.75 ICE BofAML Current 10-Year US Treasury Index (GA10)U.S. Intermediate Government-Credit Bonds 1.25 1.30 3.00 4.64 3.09 3.20 2.35 Bloomberg Barclays U.S. Intermediate Govt-Credit IndexU.S. Investment Grade Corporate Bonds 2.60 2.75 5.95 6.21 6.02 5.48 5.25 Bloomberg Barclays U.S. Corporate IndexU.S. Core Investment Grade Bonds 1.50 1.55 3.45 5.21 3.60 3.92 3.07 Bloomberg Barclays U.S. Aggregate IndexU.S. Long Credit Bonds 3.15 3.55 9.65 7.98 10.16 7.88 9.21 Bloomberg Barclays U.S. Long Credit IndexU.S. Long Government-Credit Bonds 2.05 2.45 9.30 8.01 9.79 8.10 9.41 Bloomberg Barclays U.S. Long Govt-Credit IndexU.S. High Yield Corporate Bonds 5.45 5.95 10.55 7.06 10.20 6.71 7.45 Bloomberg Barclays U.S. Corporate High Yield IndexU.S. Bank Loans 5.25 5.50 7.75 4.46 7.05 4.01 5.62 S&P/LSTA Leveraged Loan Total Return IndexEmerging Markets Sovereign Bonds 5.15 5.50 9.20 8.55 9.49 5.88 8.57 JPM EMBI Global Diversified Sovereign IndexEmerging Markets Corporate Bonds 5.00 5.35 8.90 NA NA 6.11 6.95 JPM CEMBI Broad Diversified Corporate EM IndexNon-U.S. Developed Core Bonds 1.15 1.45 7.80 4.21 8.23 2.03 7.02 Bloomberg Barclays Global Aggregate Ex-USD IndexU.S. Core Municipal Bonds 1.40 1.45 3.45 4.15 3.16 3.08 2.69 Bloomberg Barclays Municipal Bonds Index (1-10 yr)U.S. Long-Duration Municipal Bonds 2.10 2.35 7.20 5.96 6.83 5.41 6.09 Bloomberg Barclays Long Municipal Bonds Index (22+)U.S. High Yield Municipal Bonds 3.10 3.40 8.15 5.61 7.42 5.76 6.92 Bloomberg Barclays High Yield Municipal Bonds Index

ALTE

RNAT

IVES

Catastrophe Bonds 5.60 6.00 8.80 NA NA 5.85 3.82 Swiss Re Cat Bond Total Return IndexStructured Credit (CLOs/CDOs) 6.20 7.00 13.20 NA NA 5.72 8.31 J.P. Morgan CLO Mezz Total Return IndexCommodities 2.30 3.60 17.10 -2.38 15.89 -6.57 13.46 Bloomberg Commodities IndexHedge Funds - Liquid 4.60 4.85 6.95 2.31 3.98 1.48 3.74 Wilshire Focused Liquid Altrnative TR USDHedge Funds - Long/Short Equity 5.40 5.70 8.20 6.35 7.81 5.15 8.36 HFRI Equity-Hedged Hedge Fund IndexHedge Funds - Multi Strategy 5.35 5.45 5.20 5.97 5.47 5.00 5.01 HFRI Event-Drive Hedge Fund IndexGlobal Infrastructure (closed-end) 6.00 6.55 11.00 NA NA NA NA Cambridge Associates Global Tangible Assets IndexGlobal Infrastructure (open-end) 5.00 6.15 15.85 NA NA 7.03 15.47 S&P Global Infrastructure IndexMLPs 7.60 11.40 28.90 8.82 26.26 -0.06 29.84 Alerian MLP Total Return IndexU.S. Private Equity 10.00 11.25 16.50 NA NA 10.80 15.00 Cambridge Associates PE Index (50/50 VC and LBO)Global Private Equity 9.00 10.25 16.50 0.15 22.78 8.75 15.00 Average of US and European PEU.S. REITs 5.75 8.10 22.90 9.39 23.03 8.98 17.13 Dow Jones US REIT IndexGlobal. REITs 5.40 7.35 20.75 8.92 20.53 7.57 16.98 S&P Global REIT USD Total Return Index

10-year return (%)

FORE

IGN

EXCH

ANGE

EUR - USD 0.55USD - JPY 0.70GBP - USD 0.90USD - CAD -0.35USD - GBP -0.90CAD - JPY 1.05GBP-CAD 0.55GBP-EUR 0.35GBP-JPY 1.60


Risk and return trade-off Asset class detail: U�S�

Equities | Expected compound returns vs. risksExpected compound return (%)


U.S. Equity [ 7.10% | 18.20% ]

U.S. Large Cap Equity (Russell 1000®) [ 7.05% | 18.00% ]

U.S. Large Cap Equity (S&P 500®) [ 7.05% | 17.65% ]

U.S. Low Volatility Equity [ 7.05% | 13.65% ]

U.S. Mid Cap Equity [ 7.40% | 20.95% ]

U.S. Small Cap Equity [ 7.60% | 22.10% ]

U.S. Small/Mid Cap Equity [ 7.45% | 20.55% ]

U.S. Micro Cap Equity [ 7.60% | 23.40% ]

Global Equity [ 7.05% | 17.65% ]

Global Tax-Managed Equity [ 7.10% | 17.65% ]

Global Low Volatility Equity [ 7.05% | 11.35% ]

International Developed Equity [ 7.15% | 18.25% ]

International Small Cap Equity [ 7.45% | 20.90% ]

Emerging Markets Equity [ 7.55% | 23.55% ]

8 13 18 23 287.0

7.1

7.2

7.3

7.4

7.5

7.6

7.7Asset class [Compound return % | Risk %]

Equities | Expected compound returns vs risks

Fixed Income | Expected compound returns vs. risksExpected compound return (%)

Risk (standard deviation) (%)0 2 4 6 8 10 12

0

1

2

3

4

5

6

7Asset class [Compound return % | Risk %]

U.S. Cash [ 0.80% | 0.65% ]

10-yr U.S. Treasury Note [ 0.50% | 7.35% ]

U.S. Intermediate Government-Credit Bonds [ 1.25% | 3.00% ]

U.S. Investment Grade Corporate Bonds [ 2.60% | 5.95% ]

U.S. Core Investment Grade Bonds [ 1.50% | 3.45% ]

U.S. Long Credit Bonds [ 3.15% | 9.65% ]

U.S. Long Government-Credit Bonds [ 2.05% | 9.30% ]

U.S. High Yield Corporate Bonds [ 5.45% | 10.55% ]

U.S. Bank Loans [ 5.25% | 7.75% ]

Emerging Markets Sovereign Bonds [ 5.15% | 9.20% ]

Emerging Markets Corporate Bonds [ 5.00% | 8.90% ]

Non-U.S. Developed Core Bonds [ 1.15% | 7.80% ]

U.S. Core Municipal Bonds [ 1.40% | 3.45% ]

U.S. Long-Duration Municipal Bonds [ 2.10% | 7.20% ]

U.S. High Yield Municipal Bonds [ 3.10% | 8.15% ]

Fixed Income | Expected compound returns vs risks


Risk and return trade-off Asset class detail: U�S�

Alternatives | Expected compound returns vs. risksExpected compound return (%)

Risk (standard deviation) (%)0 5 10 15 20 25 30

0

2

4

6

8

10

12Asset class [Compound return % | Risk %]

Catastrophe Bonds [ 5.60% | 8.80% ]

Structured Credit (CLOs/CDOs) [ 6.20% | 13.20% ]

Commodities [ 2.30% | 17.10% ]

Hedge Funds - Liquid [ 4.60% | 6.95% ]

Hedge Funds - Long/Short Equity [ 5.40% | 8.20% ]

Hedge Funds - Multi Strategy [ 5.35% | 5.20% ]

Global Infrastructure (closed-end) [ 6.00% | 11.00% ]

Global Infrastructure (open-end) [ 5.00% | 15.85% ]

MLPs [ 7.60% | 28.90% ]

U.S. Private Equity [ 10.00% | 16.50% ]

Global Private Equity [ 9.00% | 16.50% ]

U.S. REITs [ 5.75% | 22.90% ]

Global REITs [ 5.40% | 20.75% ]

Alternatives | Expected compound returns vs risks

All assets | Expected compound returns vs. risks

Expected compound return (%)

Risk (standard deviation)

● Equities

● Fixed Income

● Alternatives

— Trend line

0 5 10 15 20 25 300

2

4

6

8

10

12

Our base premise is that markets will be in an equilibrium state over the long run, thus the risk-reward mechanism will generally place all global assets on an imaginary efficient frontier line�

10-year Capital Market AssumptionsAsset class detail: Canada


(as of May 31, 2020)1

Asset classCompound


Standard deviation

20-year compound

return


10-year compound

return


EQUI

TIES

U.S. Large Cap Equity (Russell 1000®) 7.05 8.50 18.00 6.12 16.38 13.07 15.72 Russell 1000® Index (USD)

U.S. Large Cap Equity (S&P 500®) 7.05 8.45 17.65 5.94 16.02 13.14 15.38 S&P 500® Index (USD)

U.S. Large Cap Equity (S&P 500®, in CAD, unhedged) 6.70 7.60 14.15 NA NA 16.29 12.35 S&P 500® Index (CAD, unhedged)

U.S. Large Cap Equity (S&P 500®, in CAD, hedged) 7.20 8.70 17.30 NA NA 10.25 15.11 S&P 500® Index (CAD, hedged)

U.S. Small/Mid Cap Equity 7.45 9.35 20.55 8.13 20.16 10.32 19.74 Russell 2500 Index (USD)

International Developed Equity 7.15 8.65 18.25 3.48 17.49 5.86 16.08 MSCI EAFE® Index (USD)

Emerging Markets Equity 7.55 10.05 23.55 6.69 23.78 2.83 18.60 MSCI Emerging Markets Index (USD)

Canadian Large Cap Equity 6.80 8.05 16.00 5.17 14.96 5.68 12.12 S&P/TSX Composite Index

Canadian Income Equity 6.10 6.90 13.30 6.89 13.39 6.11 11.49 FTSE Canada High Dividend Yield Index

Canadian Small Cap Equity 7.60 9.75 21.90 2.78 19.90 0.65 19.68 S&P/TSX Small Cap Index

Canadian Preferred Equity 5.80 6.75 14.55 NA NA 0.73 10.99 TSX Preferred Share Index

FIXED

INCO

ME

U.S. Cash 0.80 0.80 0.65 1.68 0.54 0.64 0.25 ICE BofAML US 3-Month Treasury Bill Index (USD)

U.S. High Yield Corporate Bonds 5.45 5.95 10.55 7.06 10.20 6.71 7.45 Bloomberg Barclays U.S. Corporate High Yield Index (USD)

Canadian Cash 0.95 0.95 0.40 1.94 0.42 0.94 0.11 Bloomberg Generic 3-mo Canadian Government Yield

Canadian Government Bonds 0.75 0.80 3.35 NA NA 3.55 3.35 FTSE TMX Canada Federal Bonds Index

Canadian Core Inv. Grade Bonds 1.55 1.60 3.80 NA NA 4.64 4.01 FTSE TMX Canada Universe Index

Canadian Core Inv. Grade Short-term Bonds 1.50 1.50 1.70 NA NA 2.64 1.49 FTSE TMX Short Term Overall Bond Index

Canadian Core Inv. Grade Mid-term Bonds 1.50 1.60 4.25 NA NA 5.09 4.14 FTSE TMX Mid Term Overall Bond Index

Canadian IG Corporate Bonds 2.65 2.70 3.95 NA NA 4.91 3.92 FTSE TMX Universe All Corporate Bonds Index

Canadian IG Short-Term Corporate Bonds 2.35 2.40 2.00 NA NA 3.28 1.84 FTSE TMX Short Term Corporate Bonds Index

Canadian IG Mid-Term Corporate Bonds 2.65 2.75 4.65 NA NA 5.69 4.56 FTSE TMX Mid Term Corporate Bonds Index

Canadian IG Long-Term Corporate Bonds 2.90 3.20 8.05 NA NA 7.71 8.15 FTSE TMX Long Term Corporate Bonds Index

ALTS Canadian REITs 5.50 6.75 16.95 9.02 15.65 7.99 14.44 S&P/TSX Capped REIT Index

10-year return (%)

FORE

IGN

EXCH

ANGE

EUR - USD 0.55USD - JPY 0.70GBP - USD 0.90USD - CAD -0.35USD - GBP -0.90CAD - JPY 1.05GBP - CAD 0.55GBP - EUR 0.35GBP - JPY 1.60

9

1 If historical data is shorter than specified, the statistics are calcultated using the longest available historical performance. All historical performance is expressed in CAD unless otherwise indicated.

Source: Bloomberg, BMO Global Asset Management, BMO Wealth Management


Risk and return trade-off Broad asset classes: Canada

Our base premise is that markets will be in an equilibrium state over the long run, thus the risk-reward mechanism will generally place all global assets on an imaginary efficient frontier line�

The expected returns and risks, as measured by standard deviation, for various asset classes align reasonably well with a concave function that associates higher expected return with higher risk, but with diminishing additional returns at greater risk levels.

It is important to note, however, that standard deviation as a risk measure does not fully capture the overall portfolio risk or other risk dimensions such as liquidity risk and excess tail risk.

These multiple risks will be present across asset classes to varying degrees.

To the extent that volatility risk does correlate with overall portfolio risk and other risks, the accompanying graphs point an asset class’ risk and return relative to that of other asset classes.

Broad assets | Expected average returns vs. risks Expected average return (%)


● Equities

● Fixed Income

0 5 10 15 20 250

2

4

6

8

10

12


Risk and return trade-off Asset class detail: Canada

Equities | Expected compound returns vs. risksExpected compound return (%)


U.S. Large Cap Equity (Russell 1000) [ 7.05% | 18.00% ]

U.S. Large Cap Equity (S&P 500) [ 7.05% | 17.65% ]

U.S. Large Cap Equity (S&P 500, in CAD, unhedged) [ 6.70% | 14.15% ]

U.S. Large Cap Equity (S&P 500, in CAD, hedged) [ 7.20% | 17.30% ]

U.S. Small/Mid Cap Equity [ 7.45% | 20.55% ]

International Developed Equity [ 7.15% | 18.25% ]

Emerging Markets Equity [ 7.55% | 23.55% ]

Canadian Large Cap Equity [ 6.80% | 16.00% ]

Canadian Income Equity [ 6.10% | 13.30% ]

Canadian Small Cap Equity [ 7.60% | 21.90% ]

Canadian Preferred Equity [ 5.80% | 14.55% ]

10.0 12.5 15.0 17.5 20.0 22.5 25.0 27.54.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5Asset Class [Compound Return % | Risk %]

Fixed Income | Expected compound returns vs. risksExpected compound return (%)

Risk (standard deviation) (%)0 4 8 12

0

1

2

3

4

5

6

7U.S. Cash [ 0.80% | 0.65% ]

U.S. High Yield Corporate Bonds [ 5.45% | 10.55% ]

Canadian Cash [ 0.95% | 0.40% ]

Canadian Government Bonds [ 0.75% | 3.35% ]

Canadian Core Inv. Grade Bonds [ 1.55% | 3.80% ]

Canadian Core Inv. Grade Short-term Bonds [ 1.50% | 1.70% ]

Canadian Core Inv. Grade Mid-term Bonds [ 1.50% | 4.25% ]

Canadian IG Corporate Bonds [ 2.65% | 3.95% ]

Canadian IG Short-Term Corporate Bonds [ 2.35% | 2.00% ]

Canadian IG Mid-Term Corporate Bonds [ 2.65% | 4.65% ]

Canadian IG Long-Term Corporate Bonds [ 2.90% | 8.05% ]

Asset Class [Compound Return % | Risk %]

This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested. Investments cannot be made in an index. Past performance is not necessarily a guide to future performance. The firm maintains a complete list and description of composites and GIPS® performance disclosures which are available upon request.

BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management, retirement, and trust and custody services. Certain of the products and services offered under the brand name BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations. BMO Financial Group is a service mark of Bank of Montreal (BMO).

Simulated returns of the proposed allocation strategy do not reflect the deduction of investment advisory fees, as such actual returns may be reduced by advisory fees and any other expenses it may incur in the management of the advisory account. The performance and sample portfolio characteristic information of the proposal was simulated using the assumptions and model portfolio characterizations that would be used to manage the proposed portfolio. The sample portfolio is not based on actual results and no actual investments have been managed under this specific proposed strategy. Presentation of these hypothetical results does not, in any way guarantee that future performance will achieve similar results. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. A complete list and description of composites is available upon request.

Representative account expected returns are based on hypothetical performance and do not represent actual investment performance. Expected returns are representative of BMO Global Asset Management specialist opinion of prevailing yield rates at the time. Yields are not representative of an Index, representative account, composite, or any account managed by BMO Global Asset Management. Yields presented are hypothetical (they do not reflect trading conducted in actual accounts or composites) and is provided for informational purposes to indicate general historical yields had the strategy been available over the relevant period. Presentation of these hypothetical yields results does not, in any way, guarantee that future yields will achieve similar results.

Sample accounts used for these demonstration purposes may be managed in a manner the same as, or substantially similar to, that of a typical managed account; examples of, but not limited to, the differences in the management of actual institutional accounts may be due to size, number of securities contained, specific client guideline restrictions, or tax or other strategy limitations. BMO Global Asset Management has attempted to set the factors, model settings, and limitations for this presentation to best represent the most realistic or most common institutional account mandate for this strategy presentation.

BMO Global Asset Management may compensate some of its employees for client referrals. It also may enter into an arrangement where payments are made to the firm’s affiliates, Bank of Montreal, the BMO Harris, N.A., and other entities in the BMO group of companies for clients referred from certain areas of BMO. Such payments are made at the firm’s expense and do not result in any additional fee to advisory clients.

®”BMO (M-bar roundel symbol)” is a registered trademark of Bank of Montreal, used under license.

Institutional Investors

bmo.com/gam/ca/institutional

[email protected]

Investment Advisors

1-800-668-7327

bmo.com/gam/ca/advisor

(10536259, 06/20)

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