Although Canadian pension funds have largely neglected international assets, diversification into international equity over the past 13 years would have offered Canadian money managers significant improvements in risk-reward tradeoffs. In fact, the optimal portfolio mixes with international assets do not even include Canadian stocks and bonds.

The optimal portfolios derived from mean-variance models are, however, sensitive to the economic variables that enter the equation. Over a recent “bad” economic period in Canada, international stocks did not enter the efficient frontier, while Canadian stocks were the dominant equity asset class. In contrast, over a “good” economic period, international stocks were the dominant equity asset class, while both Canadian bonds and bills played significant roles.

International bonds did not enter the efficient frontier of either economic scenario. However, international bonds can have an important role to play in specialist fixed income portfolios.

The optimal portfolios produced from statistics determined over a long period of history can be “inefficient” over distinct economic environments within the same data period. This suggests that strategic asset mixes could be improved by defining the current economic environment and taking into account any major structural shifts that could affect it.