Note: The following strategies guide our advice to clients and are reflected in the fund allocations for the Founders Fund.
The equity markets have experienced increased volatility over the last six months – three months ‘down’ and the most recent three ‘up’. It’s a reminder of how unpredictable markets are in the short term.
As our previous commentaries have indicated, we took advantage of this turbulence to shift gears. We had previously been counselling caution, but with lower stock prices and more fearful investors, we felt it was time to move from defense to offence.
Our actions in the Founders Fund (and advice to clients) was to add to stocks. The equity content in the fund increased from the mid-50% range to the low 60’s between late November and Christmas. In our equity funds, the managers were more active than usual, adding to existing holdings as well as buying a number of new companies.
The increased activity was based on an improvement to our 5-year outlook for returns, not a view that stocks would soon reverse course. As it so happened, the stock market abruptly turned over the Christmas holiday and hasn’t looked back since.
We now believe that balanced portfolios should be in line with their long-term equity targets. On the fixed income side, we prefer to diversify between bonds and cash.
On an absolute basis, the risk versus return trade-off in bonds remains unattractive. Real yields (the yield after accounting for inflation) are around zero. In the last six months, bond yields have fallen again (and bond prices have risen) as investors worry about the fragility of the Canadian economy.
Yields may remain at low levels, or fall further if the economy falters, but as long-term investors we're looking further out and assessing the likelihood that they will normalize over time. Over the next five years, we expect bonds to return between 2-3% per year, which translates to a 10-15% cumulative return. These returns are likely to come with higher volatility than investors have been accustomed to.
Bonds provide ballast to a portfolio when stocks are volatile (as was the case in the fourth quarter of 2018) and as such, are an important diversifier for a balanced portfolio. Nonetheless, we continue to recommend keeping bond holdings below your long-term target and setting aside a cash reserve. The Founders Fund currently holds 25% in bonds and 15% in cash — 10% more than its long-term target.
When considering how much to invest in stocks, we focus on the opportunities our managers see and the attractiveness of stocks in general. Our best estimate for 5-year stock market returns is 6-8% per year (30-45% cumulative). For context, prior to the fourth quarter price declines our estimate was 4-6%.
We recommend investors keep their stock allocation in line with their long-tem target. The Founders Fund currently holds 60% of its assets in Canadian and global stocks.
If you would like an assessment of your portfolio or a second opinion, give us a call (1-888-888-3147). We provide advice and can help better align your investments to your personal situation.
Founders Fund Asset Mix: March 13, 2019